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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION    FORM 10-Q  (Mark One)[X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the quarterly period ended June 30, 2004 OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the transition period from  to 
Commission File Number 1-31951 eFunds Corporation  Delaware
(State or other jurisdiction of incorporation or organization)
    
    39-1506286
(IRS Employer Identification Number)Gainey Center II8501 N. Scottsdale Road, Suite 300Scottsdale, Arizona
    
    85253(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (480) 629-7700 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days.Yes [X] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [  ] The number of shares outstanding of the registrants common stock, par value $.01 per share, at July 29, 2004 was 48,189,394




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONITEM 1. FINANCIAL STATEMENTSCONDENSED CONSOLIDATED BALANCE SHEETSCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONSCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 4. CONTROLS AND PROCEDURESPART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSITEM 5. OTHER INFORMATIONITEM 6. EXHIBITS AND REPORTS ON FORM 8-KSIGNATURESIndex to ExhibitsExhibit 2.1Exhibit 31.1Exhibit 31.2Exhibit 32.1    Table of Contents  
 PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS 
 eFUNDS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)June 30,
    
    December 31,(dollars in thousands)
    
    2004
    
    2003Current assets:Cash and cash equivalents
    
    $
    174,942
    
    
    $
    158,106Deposits subject to compensating balance arrangements
    
    
    1,695
    
    
    
    472Restricted custodial cash
    
    
    3,296
    
    
    
    4,168Accounts receivable  net
    
    
    70,958
    
    
    
    63,841Deferred income taxes
    
    
    11,258
    
    
    
    12,743Prepaid expenses and other current assets
    
    
    12,939
    
    
    
    16,979Total current assets
    
    
    275,088
    
    
    
    256,309Property and equipment  net
    
    
    52,065
    
    
    
    49,629Long-term investments
    
    
    2,736
    
    
    
    3,243Goodwill
    
    
    134,836
    
    
    
    128,586Other intangible assets  net
    
    
    65,682
    
    
    
    71,116Other non-current assets
    
    
    3,476
    
    
    
    3,454Total non-current assets
    
    
    258,795
    
    
    
    256,028Total assets
    
    $
    533,883
    
    
    $
    512,337Current liabilities:Accounts payable
    
    $
    25,718
    
    
    $
    26,585Accrued liabilities
    
    
    45,773
    
    
    
    51,646Accrued contract losses
    
    
    1,701
    
    
    
    1,890Deferred revenue
    
    
    11,693
    
    
    
    7,900Long-term debt due within one year
    
    
    2,264
    
    
    
    5,586Total current liabilities
    
    
    87,149
    
    
    
    93,607Long-term debt
    
    
    3,692
    
    
    
    1,667Deferred income taxes
    
    
    10,219
    
    
    
    11,400Other long-term liabilities
    
    
    2,932
    
    
    
    4,001Total liabilities
    
    
    103,992
    
    
    
    110,675Commitments and contingencies (Notes 3 & 11)Stockholders equity:Preferred stock $.01 par value; 100,000,000 shares authorized; no shares
issued and outstanding
    
    
    
    
    
    
    Common stock $.01 par value (authorized: 250,000,000 shares; issued and
outstanding: 48,000,142 shares at June 30, 2004 and 47,299,742 at
December 31, 2003)
    
    
    480
    
    
    
    473Additional paid-in capital
    
    
    428,031
    
    
    
    418,496Retained earnings (accumulated deficit)
    
    
    1,215
    
    
    
    (17,587
    )Accumulated other comprehensive gain
    
    
    165
    
    
    
    280Stockholders equity
    
    
    429,891
    
    
    
    401,662Total liabilities and stockholders equity
    
    $
    533,883
    
    
    $
    512,337
 See Notes to Condensed Consolidated Financial Statements 1




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eFUNDS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) Three Months Ended June 30,
    
    Six Months Ended June 30,(in thousands, except per share amounts)
    
    2004
    
    2003
    
    2004
    
    2003Net revenue
    
    $
    140,712
    
    
    $
    132,956
    
    
    $
    281,598
    
    
    $
    263,484Operating expenses:Processing, communication and service costs
    
    
    56,661
    
    
    
    59,939
    
    
    
    115,331
    
    
    
    115,645Employee costs
    
    
    47,787
    
    
    
    45,084
    
    
    
    96,729
    
    
    
    92,013Depreciation and amortization
    
    
    9,027
    
    
    
    8,834
    
    
    
    17,956
    
    
    
    17,623Other operating costs
    
    
    13,108
    
    
    
    12,185
    
    
    
    23,431
    
    
    
    24,712Restructuring and provision for contract loss charges
    
    
    1,253
    
    
    
    
    
    
    
    1,253
    
    
    
    Total operating expenses
    
    
    127,836
    
    
    
    126,042
    
    
    
    254,700
    
    
    
    249,993Income from operations
    
    
    12,876
    
    
    
    6,914
    
    
    
    26,898
    
    
    
    13,491Other income (expense)  net
    
    
    585
    
    
    
    616
    
    
    
    (39
    )
    
    
    860Income before income taxes
    
    
    13,461
    
    
    
    7,530
    
    
    
    26,859
    
    
    
    14,351Provision for income taxes
    
    
    (4,038
    )
    
    
    (2,417
    )
    
    
    (8,057
    )
    
    
    (4,606
    )Net income
    
    $
    9,423
    
    
    $
    5,113
    
    
    $
    18,802
    
    
    $
    9,745Weighted average shares outstanding
    
    
    47,886
    
    
    
    46,754
    
    
    
    47,786
    
    
    
    46,729Weighted average shares and potential dilutive shares outstanding
    
    
    49,268
    
    
    
    47,031
    
    
    
    49,192
    
    
    
    46,876Net income per share  basic
    
    $
    0.20
    
    
    $
    0.11
    
    
    $
    0.39
    
    
    $
    0.21Net income per share  diluted
    
    $
    0.19
    
    
    $
    0.11
    
    
    $
    0.38
    
    
    $
    0.21
 See Notes to Condensed Consolidated Financial Statements 2




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eFUNDS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Six Months EndedJune 30,(in thousands)
    
    2004
    
    2003Cash flows from operating activities:Net income
    
    $
    18,802
    
    
    $
    9,745Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation
    
    
    6,488
    
    
    
    7,380Amortization
    
    
    11,468
    
    
    
    10,243Loss on impairment or disposals of assets
    
    
    336
    
    
    
    340Provision for contract loss
    
    
    501
    
    
    
    Changes in assets and liabilities:Restricted custodial cash
    
    
    872
    
    
    
    742Accounts receivable
    
    
    (6,834
    )
    
    
    (506
    )Accounts payable
    
    
    (977
    )
    
    
    (8,416
    )Accrued contract losses
    
    
    (690
    )
    
    
    (1,920
    )Deferred revenue
    
    
    3,486
    
    
    
    5,172Other assets and liabilities
    
    
    (2,646
    )
    
    
    13,544Net cash provided by operating activities
    
    
    30,806
    
    
    
    36,324Cash flows from investing activities:Capital expenditures
    
    
    (11,423
    )
    
    
    (8,950
    )Acquisitions
    
    
    (6,079
    )
    
    
    Proceeds from sale of property and equipment
    
    
    
    
    
    
    11,938Other
    
    
    (508
    )
    
    
    (2,218
    )Net cash (used in) provided by investing activities
    
    
    (18,010
    )
    
    
    770Cash flows from financing activities:Payments on long-term debt
    
    
    (4,185
    )
    
    
    (922
    )Issuance of common stock
    
    
    8,225
    
    
    
    619Net cash provided by (used in) financing activities
    
    
    4,040
    
    
    
    (303
    )Net increase in cash and cash equivalents
    
    
    16,836
    
    
    
    36,791Cash and cash equivalents at beginning of period
    
    
    158,106
    
    
    
    119,487Cash and cash equivalents at end of period
    
    $
    174,942
    
    
    $
    156,278Supplemental disclosures:Cash paid for income taxes
    
    $
    4,934
    
    
    $
    1,349Cash paid for interest
    
    $
    158
    
    
    $
    124Noncash investing and financing activities:Purchase of assets under capital lease obligations
    
    $
    3,650
    
    
    $
    878
 See Notes to Condensed Consolidated Financial Statements 3




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eFUNDS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) NOTE 1  DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION: The goal of eFunds Corporation and its wholly-owned subsidiaries (the Company)
is to enable trusted commerce by delivering integrated information, payment and
technology solutions that strengthen the customers overall profitability
through increased revenue, reduced costs and improved operating efficiency and
technology performance. The Companys principal focus is on issuers of
transaction accounts, such as financial institutions, financial services
companies, electronic funds transfer networks, retailers, government agencies,
telecommunications companies and other businesses. The Company delivers
information, payment and technology solutions through four basic business units
and through combinations of the products and services offered by these units. The Company has four operating segments: Electronic Payments; Risk Management;
Automated Teller Machine (ATM) Management; and Global Outsourcing. The
Electronic Payments segment provides electronic funds transfer (EFT) processing
services, including automated clearinghouse (ACH) processing, electronic
benefit transfer (EBT) services for government agencies, EFT software, software
applications development, maintenance and installation. The Risk Management
segment provides risk management based data and other products to financial
institutions, retailers and other businesses that assist in detecting fraud and
assessing the risk of opening a new account or accepting a check. The ATM
Management segment provides ATM deployment, management and branding services.
The Global Outsourcing segment provides business process outsourcing services
and information technology services. The Company was incorporated in Delaware in December 1984. Prior to its
initial public offering (the IPO) in June 2000, the Company was a wholly-owned
subsidiary of Deluxe Corporation (Deluxe). In December 2000, Deluxe distributed
all of its remaining shares of the Companys common stock to its shareholders
through a spin-off transaction (Spin-Off). The unaudited condensed consolidated financial statements of the Company for
the three and six month periods ended June 30, 2004 and 2003 have been prepared
in accordance with accounting principles generally accepted in the United
States of America and the instructions to Form 10-Q and Article 10 of
Regulation S-X. All material intercompany accounts and transactions have been
eliminated. In the opinion of management, all adjustments considered necessary
for a fair presentation, which are of a normal recurring nature, have been
included. Interim results are not necessarily indicative of results for a full
year. These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto for
the year ended December 31, 2003 included in the Companys 2003 Annual Report
on Form 10-K filed with the Securities and Exchange Commission (SEC). NOTE 2  SIGNIFICANT ACCOUNTING POLICIES: New Accounting Pronouncements In December 2003, the Financial Accounting Standards Board (FASB) revised FASB
Interpretation (FIN) No. 46, Consolidation of Variable Interest Entities (FIN
46R), which addresses how a business enterprise should evaluate whether it has
a controlling financial interest in an entity through means other than voting
rights and accordingly should consolidate the entity. FIN 46R replaces FIN No.
46, Consolidation of Variable Interest Entities, which was issued in January
2003. FIN 46R is required for all enterprises with variable interests in
variable interest entities (VIEs) created after December 31, 2003. For variable
interests in VIEs created before January 1, 2004, FIN 46R will be applied
beginning on January 1, 2005, with effective dates for public enterprises
varying based on the type of VIE, whether the public enterprise is a small
business issuer and whether the original interpretation issued in January 2003
was applied to a VIE prior to the effective date of FIN 46R. For any VIEs that
must be consolidated under FIN 46R that were created before January 1, 2004,
the assets, liabilities and noncontrolling interests of the VIE initially would
be measured at their carrying amounts with any difference between the net
amount added to the balance sheet and any previously recognized interest being
recognized as the cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date FIN 46R first
applies may be used to measure the assets, liabilities and noncontrolling
interest of the VIE. The adoption of FIN 46R did not have an impact on the
Companys condensed consolidated financial position or results of operations. 4




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Employee Stock-Based Compensation The Company accounts for the issuance of stock options to employees using the
intrinsic value method prescribed by Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net
income as all options granted under the Companys plans had an exercise price
at least equal to the market value of the underlying common stock on the date
of grant. The following table illustrates the effect on net income and
earnings per share that would result if the Company had applied the fair value
recognition provision of Statement of Financial Accounting Standards (SFAS) No.
123, Accounting for Stock-Based Compensation, to its stock-based employee
compensation during the periods indicated: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(in thousands, except per share amounts)
    
    2004
    
    2003
    
    2004
    
    2003Net income, as reported
    
    $
    9,423
    
    
    $
    5,113
    
    
    $
    18,802
    
    
    $
    9,745Total stock-based employee compensation
expense determined under fair value
based method for all awards, net of tax
    
    
    (1,021
    )
    
    
    (735
    )
    
    
    (1,860
    )
    
    
    (1,292
    )Pro forma net income
    
    $
    8,402
    
    
    $
    4,378
    
    
    $
    16,942
    
    
    $
    8,453Earnings per share:Basic-as reported
    
    $
    0.20
    
    
    $
    0.11
    
    
    $
    0.39
    
    
    $
    0.21Basic-pro forma
    
    $
    0.18
    
    
    $
    0.09
    
    
    $
    0.35
    
    
    $
    0.18Diluted-as reported
    
    $
    0.19
    
    
    $
    0.11
    
    
    $
    0.38
    
    
    $
    0.21Diluted-pro forma
    
    $
    0.17
    
    
    $
    0.09
    
    
    $
    0.34
    
    
    $
    0.18
 For purposes of applying SFAS No. 123, the weighted average estimated fair
value of stock options granted during the three and six month periods ended
June 30, 2004 was $7.39 and $7.83, respectively, and for the same periods in
2003 was $3.33 and $3.62, respectively. This value was estimated at the option
grant date using a Black-Scholes option-pricing model. From time to time the Company issues restricted stock unit awards to employees
and directors that generally vest over periods ranging from one to three years.
No consideration is paid for these awards. During the three and six month
periods ended June 30, 2004, the Company issued 2,843 and 131,594 units of
restricted stock, respectively, and for the same periods in 2003 issued 1,190
and 17,434 units, respectively. The Company recorded compensation expense for
restricted stock unit awards during the three and six months ended June 30,
2004 of approximately $227,000 and $343,000, respectively, and for the same
periods in 2003 the Company recorded compensation expense for restricted stock
unit awards of approximately $84,000 and $126,000, respectively. NOTE 3 
ACQUISITIONS:
In April of 2004, the Company acquired Penley, Inc. (Penley), which provides
identity verification services, and Loss Control Solutions (LCS), which offers
fraud investigation case management software for the financial services
industry. The primary reason for these acquisitions was to expand the product
suite and customer set within the Risk Management segment. The results of
operations for the acquired entities have been included in the Companys
statements of operations since the acquisition dates. The aggregate initial purchase price paid for the entities was approximately $6
million, of which approximately $5 million was funded from existing cash on
hand. Approximately $0.6 million of the purchase price was placed in escrow
subject to the satisfaction of certain post-closing conditions. Additional
amounts could become payable to the former stockholders of Penley if the
acquired business achieves certain revenue and income targets during the two
year period following the acquisition. The maximum additional amount payable
to such stockholders is $21 million. The results of operations of Penley and LCS are not material to the Company,
and accordingly, pro forma results of operations for the acquisitions are not
disclosed. The estimated fair value of the net assets acquired was
approximately $6 million, which included approximately $5 million of goodwill
and approximately $1 million of intangible assets related to acquired contracts
which have an estimated life of approximately 6 years. All goodwill and
intangible assets were assigned to the Risk Management segment. 5




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NOTE 4  INTANGIBLES: Intangible assets consist primarily of goodwill, capitalized software costs and
acquired contracts. Intangible assets, both acquired and developed, subject to
amortization were as follows: June 30, 2004
    
    December 31, 2003Wtd. Avg.Amort.
    
    Gross
    
    
    
    
    
    
    
    
    
    GrossPeriod
    
    Carrying
    
    Accumulated
    
    
    
    
    
    Carrying
    
    Accumulated(dollars in thousands)
    
    In Years
    
    Amounts
    
    Amortization
    
    Net
    
    Amounts
    
    Amortization
    
    NetSoftware-internal use
    
    
    4.1
    
    
    $
    84,568
    
    
    $
    (57,856
    )
    
    $
    26,712
    
    
    $
    82,376
    
    
    $
    (52,823
    )
    
    $
    29,553Acquired contracts
    
    
    13.5
    
    
    
    23,286
    
    
    
    (5,009
    )
    
    
    18,277
    
    
    
    22,262
    
    
    
    (3,599
    )
    
    
    18,663Other
    
    
    5.4
    
    
    
    90,509
    
    
    
    (69,816
    )
    
    
    20,693
    
    
    
    89,542
    
    
    
    (66,642
    )
    
    
    22,900$
    198,363
    
    
    $
    (132,681
    )
    
    $
    65,682
    
    
    $
    194,180
    
    
    $
    (123,064
    )
    
    $
    71,116
 Net other intangible assets of $20.7 million consist primarily of capitalized
costs related to software developed for licensing and resale and other assets
obtained in connection with the acquisition of other companies, such as
non-competition agreements. For the three and six month periods ended June 30,
2004, amortization expense for intangible assets was $6.0 million and $11.5
million, respectively, and for the three and six month periods ended June 30,
2003 the amortization expense for intangible assets was $5.1 million and $10.2
million, respectively. The estimated amortization expense for intangible assets
held at June 30, 2004 is $11 million for the six months ended December 31,
2004. For the years ended December 31, 2005, 2006, 2007 and 2008, the
estimated amortization expense for intangible assets held at June 30, 2004 is
$16 million, $11 million, $7 million and $5 million, respectively. The change in the carrying amount of goodwill for the six months ended June 30,
2004 is as follows: Electronic
    
    Risk
    
    ATM
    
    Global(in thousands)
    
    Payments
    
    Management
    
    Management
    
    Outsourcing
    
    Other
    
    TotalBalance as of December 31, 2003
    
    $
    14,960
    
    
    $
    5,724
    
    
    $
    77,982
    
    
    $
    20,559
    
    
    $
    9,361
    
    
    $
    128,586Goodwill acquired
    
    
    285
    
    
    
    5,169
    
    
    
    
    
    
    
    
    
    
    
    796
    
    
    
    6,250Balance as of June 30, 2004
    
    $
    15,245
    
    
    $
    10,893
    
    
    $
    77,982
    
    
    $
    20,559
    
    
    $
    10,157
    
    
    $
    134,836
 NOTE 5  RESTRUCTURING, ASSET IMPAIRMENT AND OTHER CHARGES: During the three months ended June 30, 2004, the Company recorded approximately
$0.8 million of restructuring charges related to severance benefits for
approximately 35 employees. These charges are expected to be paid through 2005.
The following table summarizes the change in the Companys restructuring
accruals for the six months ended June 30, 2004, including the long-term
portion of lease related accruals of approximately $1.5 million at June 30,
2004 that are payable through January 2010: Lease-RelatedSeverance
    
    Costs(in thousands)
    
    Related
    
    & Other
    
    TotalBalance at December 31, 2003
    
    $
    1,568
    
    
    $
    2,786
    
    
    $
    4,354Cash payments
    
    
    (881
    )
    
    
    (250
    )
    
    
    (1,131
    )Balance at March 31, 2004
    
    
    687
    
    
    
    2,536
    
    
    
    3,223Expense provision
    
    
    752
    
    
    
    
    
    
    
    752Cash payments
    
    
    (657
    )
    
    
    (219
    )
    
    
    (876
    )Balance at June 30, 2004
    
    $
    782
    
    
    $
    2,317
    
    
    $
    3,099
 NOTE 6  ACCRUED CONTRACT LOSSES: Through March 31, 2004, the Companys accrued contract losses pertained to
long-term service contracts for electronic benefits processing in the
Electronic Payments segment. During the second quarter of 2004, a $0.5 million
provision for contract losses was recorded for certain long-term software
contracts held by this segment. These contracts require significant
modification to the underlying software and the revenue associated with the
contracts was recognized using the percentage-of-completion method, which
relies on estimates of total expected contract costs. Unexpected increases in
the scope of these projects resulted in unanticipated increases in the expense
required to perform the contracts with the result that the Company now expects
to incur losses in the performance of these contracts. The losses recorded are
based on the Companys best current estimates of the contracts ultimate
revenues and expenses. Actual results may differ from the Companys estimates.
In the event such differences arise, 6




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a revision to the loss reserve would be required. The following table
summarizes the activity of the accrued contract loss reserve: (in thousands)
    
    2004
    
    2003Balance at beginning of year
    
    $
    1,890
    
    
    $
    7,578Charges to reserve
    
    
    (345
    )
    
    
    (1,003
    )Balance at March 31
    
    
    1,545
    
    
    
    6,575Provision for contract losses
    
    
    501
    
    
    
    Charges to reserve
    
    
    (345
    )
    
    
    (917
    )Balance at June 30
    
    $
    1,701
    
    
    $
    5,658
 NOTE 7  LONG-TERM DEBT: Long-term debt was as follows: June 30,
    
    December 31,(in thousands)
    
    2004
    
    2003Capital leases and other
    
    $
    5,956
    
    
    $
    7,253Less amount due within one year
    
    
    (2,264
    )
    
    
    (5,586
    )Total
    
    $
    3,692
    
    
    $
    1,667
 Long-term debt consists principally of capital lease obligations related to
purchased software and equipment. The range of interest rates on capital lease
obligations is approximately 2% to 9%. Carrying value approximates fair value
for these obligations, which are due through the year 2009. NOTE 8  INCOME PER SHARE: The following table reflects the calculation of basic and diluted income per
share: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(in thousands, except per share amounts)
    
    2004
    
    2003
    
    2004
    
    2003Net income per share  basicNet income
    
    $
    9,423
    
    
    $
    5,113
    
    
    $
    18,802
    
    
    $
    9,745Weighted average shares outstanding
    
    
    47,886
    
    
    
    46,754
    
    
    
    47,786
    
    
    
    46,729Net income per share  basic
    
    $
    0.20
    
    
    $
    0.11
    
    
    $
    0.39
    
    
    $
    0.21Net income per share  dilutedNet income
    
    $
    9,423
    
    
    $
    5,113
    
    
    $
    18,802
    
    
    $
    9,745Weighted average shares outstanding
    
    
    47,886
    
    
    
    46,754
    
    
    
    47,786
    
    
    
    46,729Dilutive impact of options
    
    
    1,382
    
    
    
    277
    
    
    
    1,406
    
    
    
    147Weighted average shares and potential dilutive shares outstanding
    
    
    49,268
    
    
    
    47,031
    
    
    
    49,192
    
    
    
    46,876Net income per share  diluted
    
    $
    0.19
    
    
    $
    0.11
    
    
    $
    0.38
    
    
    $
    0.21
 Options to purchase approximately 196,000 shares and 3,694,000 shares of common
stock were excluded from the above calculations as they were antidilutive at
June 30, 2004 and 2003, respectively. NOTE 9  COMPREHENSIVE INCOME: The Companys total comprehensive income for the three month periods ended June
30, 2004 and 2003 was $7.3 million and $5.9 million, respectively. The
Companys total comprehensive income for the six month periods ended June 30,
2004 and 2003 was $18.7 million and $10.8 million, respectively. The Companys
total comprehensive income consists of net income and foreign currency
translation adjustments. NOTE 10  BUSINESS SEGMENT INFORMATION: The Companys segment reporting was revised during the quarter ended March 31,
2004 to reflect additional organizational and cost group changes. Certain
revenues and expenses from collection activities have been reclassified between
the Electronic Payments, Risk Management and Global Outsourcing segments.
Certain amortization cost groups were realigned with the respective business
segments that benefited from the use of the related assets. Currently, the
Companys business segments are: Electronic Payments; Risk Management; ATM
Management; and Global Outsourcing. The Company reports segment information
consistent with the way management internally disaggregates its operations to
assess performance and to allocate resources. The Electronic Payments segment
provides EFT processing services, including ACH processing, EBT services for
government agencies, EFT software, software applications development,
maintenance and installation. The Risk Management 7




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segment provides data based risk management services and other related products
to financial institutions, retailers and other businesses that assist in
detecting fraud and assessing the risk of opening a new account or accepting a
check. The ATM Management segment provides ATM deployment, management and
branding services. The Global Outsourcing segment provides business process
outsourcing and information technology services. The accounting policies of the segments are the same as those applied by the
Company on a consolidated basis. For internal reporting purposes, the Company
aggregates costs based upon managerial control. The majority of these managed
cost groups are directly assigned to a reportable segment. For cost groups
supporting more than one reportable segment, the costs are assigned based upon
the product line or project benefited. The assignment of costs is based upon
estimates of factors considered most appropriate for the cost group such as
transactions, calls, customers, square footage, revenues and headcount. The
Company does not allocate expenses that benefit all segments and are corporate
or administrative in nature. These costs are designated as Corporate expenses
and include, among other things, executive leadership costs, investor relations
and general legal, consulting, accounting and finance costs. Information concerning operations in the Companys reportable segments is as
follows: Three Months Ended June 30,
    
    Six Months Ended June 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Net revenue:Electronic payments
    
    $
    51,719
    
    
    $
    45,200
    
    
    $
    101,402
    
    
    $
    88,267Risk management
    
    
    35,033
    
    
    
    32,024
    
    
    
    70,157
    
    
    
    64,024ATM management
    
    
    34,573
    
    
    
    36,346
    
    
    
    69,733
    
    
    
    70,173Global outsourcing
    
    
    19,387
    
    
    
    19,386
    
    
    
    40,306
    
    
    
    41,020Total net revenue
    
    
    140,712
    
    
    
    132,956
    
    
    
    281,598
    
    
    
    263,484Operating expenses before
restructuring and provision
for contract loss charges:Electronic payments
    
    
    40,383
    
    
    
    34,339
    
    
    
    79,238
    
    
    
    66,378Risk management
    
    
    20,273
    
    
    
    22,990
    
    
    
    41,227
    
    
    
    45,746ATM management
    
    
    32,000
    
    
    
    34,060
    
    
    
    64,784
    
    
    
    66,106Global outsourcing
    
    
    14,639
    
    
    
    16,814
    
    
    
    29,843
    
    
    
    34,653Total operating expenses
before restructuring and
provision for contract loss
charges
    
    
    107,295
    
    
    
    108,203
    
    
    
    215,092
    
    
    
    212,883Allocated overhead:Electronic payments
    
    
    2,771
    
    
    
    1,593
    
    
    
    5,571
    
    
    
    3,495Risk management
    
    
    2,324
    
    
    
    2,476
    
    
    
    4,721
    
    
    
    5,249ATM management
    
    
    2,118
    
    
    
    1,629
    
    
    
    4,220
    
    
    
    3,848Global outsourcing
    
    
    1,659
    
    
    
    1,824
    
    
    
    3,332
    
    
    
    4,199Corporate
    
    
    10,416
    
    
    
    10,317
    
    
    
    20,511
    
    
    
    20,319Total allocated overhead
    
    
    19,288
    
    
    
    17,839
    
    
    
    38,355
    
    
    
    37,110Restructuring and provision
for contract loss charges:Electronic payments
    
    
    1,178
    
    
    
    
    
    
    
    1,178
    
    
    
    Risk management
    
    
    (8
    )
    
    
    
    
    
    
    (8
    )
    
    
    ATM management
    
    
    9
    
    
    
    
    
    
    
    9
    
    
    
    Global outsourcing
    
    
    41
    
    
    
    
    
    
    
    41
    
    
    
    Corporate
    
    
    33
    
    
    
    
    
    
    
    33
    
    
    
    Total restructuring and
provision for contract
loss charges
    
    
    1,253
    
    
    
    
    
    
    
    1,253
    
    
    
    Income (loss) from operations:Electronic payments
    
    
    7,387
    
    
    
    9,268
    
    
    
    15,415
    
    
    
    18,394Risk management
    
    
    12,444
    
    
    
    6,558
    
    
    
    24,217
    
    
    
    13,029ATM management
    
    
    446
    
    
    
    657
    
    
    
    720
    
    
    
    219Global outsourcing
    
    
    3,048
    
    
    
    748
    
    
    
    7,090
    
    
    
    2,168Corporate
    
    
    (10,449
    )
    
    
    (10,317
    )
    
    
    (20,544
    )
    
    
    (20,319
    )Income from operations
    
    $
    12,876
    
    
    $
    6,914
    
    
    $
    26,898
    
    
    $
    13,491
 8




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The Company has not disclosed assets, interest income, interest expense or
income taxes by segment because this information is not reviewed by the chief
operating decision maker, produced internally nor practicable to prepare.
Depreciation and amortization for each of the Companys reporting segments is
as follows: Three Months Ended June 30,
    
    Six Months Ended June 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Depreciation and amortization:Electronic payments
    
    $
    3,634
    
    
    $
    2,820
    
    
    $
    7,209
    
    
    $
    5,572Risk management
    
    
    2,788
    
    
    
    3,318
    
    
    
    5,683
    
    
    
    6,587ATM management
    
    
    1,681
    
    
    
    1,255
    
    
    
    3,018
    
    
    
    2,666Global outsourcing
    
    
    537
    
    
    
    931
    
    
    
    1,330
    
    
    
    1,828Corporate
    
    
    387
    
    
    
    510
    
    
    
    716
    
    
    
    970Total depreciation and amortization
    
    $
    9,027
    
    
    $
    8,834
    
    
    $
    17,956
    
    
    $
    17,623
 Revenue is attributed to geographic areas based on the location of the assets
producing the revenue. The Companys operations by geographic area are as
follows: Total Net RevenueThree Months Ended June 30,
    
    Six Months Ended June 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003United States
    
    $
    122,920
    
    
    $
    119,801
    
    
    $
    246,706
    
    
    $
    239,557United Kingdom
    
    
    5,267
    
    
    
    5,761
    
    
    
    11,348
    
    
    
    9,508India
    
    
    6,011
    
    
    
    4,444
    
    
    
    10,582
    
    
    
    9,012Canada
    
    
    5,685
    
    
    
    2,950
    
    
    
    11,211
    
    
    
    5,407Other
    
    
    829
    
    
    
    
    
    
    
    1,751
    
    
    
    Total consolidated
    
    $
    140,712
    
    
    $
    132,956
    
    
    $
    281,598
    
    
    $
    263,484
 Property and Equipment  NetJune 30,
    
    December 31,(in thousands)
    
    2004
    
    2003United States
    
    $
    39,240
    
    
    $
    38,594United Kingdom
    
    
    452
    
    
    
    493India
    
    
    11,400
    
    
    
    9,445Canada
    
    
    944
    
    
    
    1,060Other
    
    
    29
    
    
    
    37Total consolidated
    
    $
    52,065
    
    
    $
    49,629
 NOTE 11  COMMITMENTS AND CONTINGENCIES: Future commercial commitments In connection with the Companys government services, collection and ATM
placement activities, the Company posts surety bonds with state agencies
guaranteeing its performance of certain obligations related to the relevant
contracts or state requirements. The aggregate amount of such bonds outstanding
at June 30, 2004 was $14.2 million. At June 30, 2004, the Company provided guarantees of $0.6 million on certain
equipment lease payments for Canadian customers of its ATM management business.
These guarantees were established prior to the acquisition of Access Cash
International, L.L.C. (ACI) in 2001 and expire through March 2008. The Company
would be required to make payments under these guarantees in the event that
these customers could not meet their own payment obligations. Through June 30,
2004, the Company has been required to make payments of approximately $0.3
million pursuant to these guarantees. The customers ATM equipment assets are
utilized as collateral on these guarantees. There are no amounts being carried
as liabilities for the Companys obligations under these guarantees. The Company uses time deposits to secure letters of credit it uses in the
ordinary course of business in India. The Company had $1.2 million in letters
of credit outstanding at June 30, 2004, mostly related to leases. These letters
of credit were secured by $1.4 million in cash collateral. The Company has also
pledged $0.5 million of time deposits as collateral related to the performance
on a customer contract and certain obligations related to local government
requirements. 9




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##### Table of Contents



Contractual cash obligations As of June 30, 2004, the Company had contractual cash obligations for capital
leases, operating leases, outsourcing and maintenance obligations in the
aggregate amount of approximately $131.0 million. The following table sets
forth the Companys obligations as of June 30, 2004 for the time periods
specified. The Companys long-term debt consists primarily of capital lease
obligations related to purchased software and equipment. Payments Due by PeriodSix-months
    
    Three Years
    
    Three Yearsended
    
    ended
    
    endedDecember 31,
    
    December 31,
    
    December 31,(in thousands)
    
    Total
    
    2004
    
    2007
    
    2010
    
    ThereafterCapital lease obligations
    
    $
    5,956
    
    
    $
    1,590
    
    
    $
    3,625
    
    
    $
    741
    
    
    $
    Operating lease
obligations1
    
    
    56,236
    
    
    
    6,265
    
    
    
    24,931
    
    
    
    17,267
    
    
    
    7,773Vendor obligations
    
    
    68,842
    
    
    
    20,027
    
    
    
    48,815
    
    
    
    
    
    
    
    Total
    
    $
    131,034
    
    
    $
    27,882
    
    
    $
    77,371
    
    
    $
    18,008
    
    
    $
    7,773
  1
    Future minimum lease payments for
non-cancelable operating leases are presented net of
minimum sublease rentals of $3.5 million due in the
future under non-cancelable subleases. Other commitments The Company has vault cash agreements with various financial institutions who
provide cash to certain of the ATMs owned or managed by the Company. Although
some portion of this cash may be physically located in the ATMs managed by the
Company, this cash is not included in cash and cash equivalents on the
Companys condensed consolidated balance sheet because the Company does not
take title to the cash under the bailee/bailor relationship established by the
agreements. Based upon the daily outstanding balance of funds provided to the
ATMs, the Company generally pays a monthly fee ranging from prime, as defined,
plus one half percent up to prime plus 5%. The average monthly rate paid during
the first six months of 2004 approximated 7%. The Company indemnifies the
financial institutions against any loss of the cash in the ATMs. Two of the
agreements require the Company to maintain a security deposit equal to 1% of
the daily outstanding balance. The agreements may be terminated upon notice by
either party and have various expiration dates ranging from August 2004 to June
2005. Total cash provided pursuant to these vault cash agreements was
approximately $33 million at June 30, 2004 and approximately $41 million at
December 31, 2003. As part of its transaction processing business, the Company provides cash
settlement services to financial institutions and state and local governments.
These services involve the movement of funds between the various parties
associated with ATM, point-of-sale or EBT transactions and this activity
results in a balance due to the Company at the end of each business day that it
recoups over the next few business days. The balances due to the Company are
included in cash and cash equivalents. As of June 30, 2004, approximately
$29.1 million was due to the Company and it received these funds in early July
2004. The Company seeks to maintain cash balances that are adequate to ensure that it
can advance funds to its processing customers if unusual circumstances prevent
the Company from being able to process their settlement files in a timely
fashion. Although highly infrequent, the Company has funded approximately $30
million under such a circumstance in the past. The Company is evaluating means
to reduce the need for it to maintain these minimum cash balance levels,
including the possibility of obtaining an overnight credit facility to fund
these obligations. Under a third party indemnification agreement, the Company agreed to indemnify
Deluxe in connection with any liabilities incurred by Deluxe after the Spin-Off
as a result of Deluxes purchase or lease of property or services for the
Companys benefit under any master agreement. The Company also agreed to
indemnify Deluxe in connection with any guarantees under which Deluxe
guaranteed the Companys performance of agreements with third parties. The
Company is obligated to indemnify Deluxe for any liability to the extent such
liability primarily relates to the past, present or future operation of the
Companys business or operations. No amounts have been paid to Deluxe under
this agreement. The Company and Deluxe also entered into a Cross-Indemnification Agreement
pursuant to which both the Company and Deluxe agreed to indemnify each other
against any liabilities arising out of the underwriting agreement related to
the Companys IPO, except insofar as any such liability arises out of a breach
of such agreement by the party seeking indemnification. No payments have been
made pursuant to this agreement. 10




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The Companys agreements with users of its products and services generally
contain indemnity clauses under which the Company agrees to indemnify its
customers and hold them harmless from and against liabilities arising from
claims of patent, copyright or other intellectual property infringement brought
by a third party related to those products or services. The Companys
agreements may also provide indemnification for claims relating to property
damage or personal injury resulting from the performance of services by the
Company or its subcontractors. Historically, the Companys costs to defend
lawsuits or settle claims relating to these indemnity agreements have not been
significant. The Companys amended and restated certificate of incorporation and by-laws
require it to indemnify its directors and officers to the fullest extent
permitted by Delaware law. Indemnification of the Companys employees and
other agents is permitted to the same extent. The Companys amended and
restated certificate of incorporation also permits the Company to secure
insurance on behalf of any officer, director, employee or other agent for any
liability arising out of his or her actions in such capacity, regardless of
whether the amended and restated certificate of incorporation would permit such
indemnification. These indemnification obligations are implicated with respect
to the directors and officers of the Company named as defendants in the Federal
Securities Action and Shareholder Derivative Actions described below, and could
be implicated if any of the Companys former officers are named as individual
respondents in connection with the SEC investigation described below. In
addition, the Companys insurance carriers may decline coverage, or the
coverage may be insufficient to cover the Companys expenses and liability, in
some or all of these matters. At this time, it is not possible to estimate the
amount of loss or probable losses, if any, that might result from an adverse
resolution of these matters. Other contingencies The Company is currently the subject of an investigation by the SEC with
respect to restatements of its prior period financial statements that occurred
in 2002. The Company has been cooperating fully with the SEC staff and intends
to continue to do so. The Company may, however, become subject to a fine or
other remedies in connection with the investigation and may be required to
indemnify certain of its former officers for expenses incurred in connection
with the SEC inquiry. The Company has incurred, and may continue to incur,
significant additional legal expenses in connection with this investigation. The Company is also a nominal defendant in two substantially identical
shareholder derivative actions filed in the Superior Court of Arizona, Maricopa
County in January 2003 (the Shareholder Derivative Actions). The complaints in
these actions allege, among other things, that certain of the Companys current
and former directors named in the complaints as defendants breached their
fiduciary duties to the Company in connection with certain alleged issues
involving the Companys accounting practices and internal controls. The
complaints also name as a defendant the Companys former external auditor.
These actions were stayed pending the resolution of the motion to dismiss the
Federal Securities Action that is discussed below and the defendants
are now evaluating how to proceed in this litigation in light of the
ruling in the Federal Securities Litigation. The Company believes the Shareholder Derivative Actions are without merit and
intends to vigorously defend itself. However, the Company cannot predict the
ultimate outcome of these actions with certainty. The Company, along with numerous other defendants, is a defendant in an action
pending in the U.S. District Court for the Southern District of Florida. The
complaint in this action alleges that the Company purchased motor vehicle
records from the State of Florida and used that data for marketing and other
purposes that are not permitted under the Federal Drivers Privacy Protection
Act. The plaintiffs are seeking liquidated damages of not less than $2,500 for
each affected member of a purported class, plus costs and attorneys fees. The
plaintiffs are also asking for injunctive relief to prevent further alleged
violations of the Federal Act. On March 11, 2004, the Company
joined in a motion to dismiss this case filed by a co-defendant and
the Company filed its own further motion to dismiss a portion of this
case on June 23, 2004. On June 25, 2004 the Company filed a
motion for summary judgment. All of these motions are pending before
the Court. The Company cannot predict whether the plaintiffs in
this case will be successful in certifying their complaint as a class action.
The Company believes that it has meritorious defenses with regard to the
allegations made in this lawsuit and intends to vigorously defend this action. NOTE 12  SUBSEQUENT EVENTS: The Company, its former chief executive and chief financial officers and its
current chief financial officer were defendants in a federal securities action
(the Federal Securities Action) that was pending in the U.S. District Court for
the District of Arizona. The Consolidated Amended Complaint (Complaint) filed
in this Action alleged, among 11




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other things, that during the period from July 21, 2000 through October 24,
2002 the defendants made false and misleading statements and omissions of
material facts and that the plaintiff and other members of a putative class of
shareholders suffered damages as a result. This Complaint was dismissed by
order of the Court on July 12, 2004. 12




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Our Managements Discussion and Analysis of our Financial Condition and Results
of Operations (MD&A) begins with an executive overview of our business. This
overview includes a description of our business goals, the business models for
our segments, key events during the quarter ended June 30, 2004 and certain
trends, risks and challenges. We then discuss our results of operations for the
three and six month periods ended June 30, 2004 compared to the three and six
month periods ended June 30, 2003. This is followed by a discussion of our
liquidity and capital resources, including cash resources, sources and uses of
cash and commercial commitments. You should read the description of our
Critical Accounting Policies and Estimates in our Annual Report on Form 10-K
for the period ending December 31, 2003 because understanding these policies
and estimates is important in order to fully understand our reported financial
results and our business outlook for future periods. You should read the following discussion together with our condensed
consolidated financial statements and the notes to those financial statements
included in this Quarterly Report on Form 10-Q and our 2003 Annual Report on
Form 10-K. In addition to historical information, this discussion contains
forward-looking statements as defined in the U.S. Private Securities
Litigation Reform Act of 1995. All forward-looking statements are subject to
various risks and uncertainties that could cause our actual future results to
differ materially from those presently anticipated due to a variety of factors,
including those discussed in the risk factors and cautionary statements in Part
II, Item 5 of this Quarterly Report on Form 10-Q. EXECUTIVE OVERVIEW Our Business Our goal is to enable trusted commerce by delivering integrated information,
payment and technology solutions that strengthen our customers overall
profitability through increased revenue, reduced costs and improved operating
efficiency and technology performance. Our principal focus is on issuers of
transaction accounts, such as financial institutions, financial services
companies, electronic funds transfer networks, retailers, government agencies,
telecommunications companies and other businesses. In evaluating our financial
condition and operating results, our management focuses on revenues, operating
income, return on invested capital and cash flows. We deliver our information, payment and technology solutions through four basic
business units and through combinations of the products and services offered by
these units. Our most profitable business segments are Electronic Payments and
Risk Management, although our Global Outsourcing and Automated Teller Machine
(ATM) Management segments also contribute to our overall value proposition. One
of our goals is to enhance our ability to market and sell comprehensive
solutions incorporating multiple elements of the products and services offered
by our business lines to our customers. The business model of each of our
segments is summarized below. Electronic Payments This segment derives its revenue based upon our customers needs to process
electronic transactions. The majority of this segments revenue is derived from
processing debit transactions that originate at an ATM or point-of-sale device.
We also derive revenue from electronic benefit transfer (EBT)
services for government agencies. The remaining revenue from this segment is derived from the licensing
and maintenance of the electronic funds transfer (EFT) software that our
customers use to process electronic debit transactions. The provision of EFT
processing services requires substantial capital investment for computers and
related peripherals, maintenance, system modifications and upgrades, security
and redundancy. Although these requirements add barriers to competitive
entrance, they also create a relatively high ratio of fixed operating costs to
total costs. Processors are also required to maintain significant cash reserves
to cover temporary imbalances in the flow of funds associated with electronic
funds transfers. Additionally, the software applications used for processing at
our data centers and which we license to our software customers are primarily
developed in-house and require frequent compliance updates and competitive
upgrades, creating a dependence upon experienced and qualified information
technology (IT) personnel. Other operating expenses include telecommunications
costs to support the transmission of electronic debit transactions and
settlement. When evaluating the performance of this business, we focus
primarily on increasing its recurring revenue base through, among other things,
the retention of our current EFT and EBT processing customers and the
acquisition of new processing relationships. Expanding our software sales and
establishing a processing presence in foreign markets are also areas of
management emphasis. 13




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Risk Management This segment derives its revenue from database inquiries by financial
institutions and retailers seeking to comply with regulations or mitigate the
risk associated with accepting checks, providing credit or opening debit
accounts for new consumers. Revenue from financial institutions represented the
majority of this segments revenue during the three and six month periods ended
June 30, 2004, and the balance of the segments revenue was derived from retail
customers using our check verification service. Operating costs generally
include data acquisition costs, the cost of technology, regulatory compliance
infrastructure and customer support centers. Our primary efforts in managing
this business are directed towards increasing its revenues by improving
customer usage rates and expanding our product suite and customer set. Towards
this end, in April 2004 we acquired Penley Inc. (Penley), which provides
identity verification services, and Loss Control Solutions (LCS), which offers
fraud investigation case management software to financial institutions. We
believe the services offered by Penley and LCS may also have application to
credit card issuers, broker dealers and other issuers of transaction accounts. ATM Management Our ATM Management segment derives its revenues from the use, sale, branding,
and management of ATMs. Surcharge and interchange revenue represented the
majority of our revenue from this segment during the three and six month
periods ended June 30, 2004. Equipment sales are non-recurring and, along with
branding fees, represent a minority of the revenue in this segment. Operating
costs in this segment primarily include processing and telecommunication costs,
the cost of the equipment we sell and the residual payments we make to the
merchants where the ATMs we manage are deployed. Our primary goal for this
business is to continue to improve its margins by lowering its costs and
expanding the scope of its service offering. Global Outsourcing Our global outsourcing business derives its revenues from the need of companies
to remain competitive by reducing costs while maintaining or improving service
levels. Revenues in this segment are from a variety of business process
outsourcing (BPO) services (such as transaction account acquisition, credit
card operations, brokerage support, customer support, credit decisioning, loan
operations and collections) and IT outsourcing. Operating costs in this segment
are primarily related to employee expense and telecommunications and facilities
costs. Our principal goal for this business is to expand its customer base in
our core target markets of financial services, retail and telecommunications
companies. Key Events During the Three Months Ended June 30, 2004  
    
    Richard J. Almeida and Sheila A. Penrose were re-elected to our
Board of Directors at our annual stockholders meeting.  
    
    Hatim A. Tyabji rejoined our Board of Directors.  
    
    Richard J. Lehmann and William J. Ryan agreed to join our Board of Directors in September.  
    
    Richard J. Almeida became the Chairman of the Audit Committee of
our Board of Directors, succeeding Jack Robinson. In addition, our
Board determined that Mr. Almeida qualifies as a financial expert
under the rules of the SEC.  
    
    Our Electronic Payments segment held its 2004 International
Software Conference, which attracted approximately 200 business and
technical attendees from around the world.  
    
    We recorded a $0.8 million restructuring charge related to
severance benefits for 35 employees primarily associated with our
open systems EFT software product line.  
    
    We acquired Penley, which provides identity verification services
to financial institutions, and LCS, which offers fraud investigation
case management software.  
    
    Our ATM business executed two new surcharge-free ATM Access
agreements.  
    
    Our Global Outsourcing segment opened an approximately 50,000
square foot facility in India to support the anticipated future growth
in our BPO business.  
    
    We recorded a $0.5 million loss contract reserve because we now
anticipate that the expenses associated with completing certain
software-related projects will exceed the revenues we will receive from
these projects by that amount.  
    
    Oasis Technology Ltd. continues to incur operating losses and has
not performed up to the original expectations developed during our
acquisition of this Company. 14




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##### Table of Contents



Trends Our strategic planning and forecasting processes include the consideration of
economic, industry-wide and Company specific trends that may impact our
customers, competitors and operations. We identify the more material positive
and negative trends affecting our business below:  
    
    increased fraud and identity theft and regulatory requirements are
driving an increasing need for risk management products;  
    
    consolidation in industries we serve is resulting in increasing competition and pricing pressures;  
    
    we are seeing an improving pipeline for our electronic payment processing business;  
    
    increased outsourcing as a means to control costs is driving a
demand for offshore outsourcing services as well as an increased level
of interest in developing expanded offshore capabilities by industry
participants;  
    
    the expanding use of offshore outsourcing services continues to be
a point of political debate;  
    
    a continued shift in the mix of payment mechanisms toward debit
transactions is driving a need for electronic payment solutions and
associated risk management services;  
    
    the demand from financial institutions for access to surcharge free ATMs is increasing;  
    
    our sales of IT outsourcing services continue to decline;  
    
    the rate of new ATM deployment and per ATM transaction volumes in the United States is declining;  
    
    the independent ATM management industry is consolidating;  
    
    the market for EFT software is soft and sales in this area
currently relate more to customer upgrades and maintenance instead of
new software sales;  
    
    ATM markets outside the United States are growing; and  
    
    our India operations continue to experience pressure on compensation costs as competition increases. Risks and Challenges In addition to the trends affecting our industry and our Company as noted
above, we consider risks and challenges that could impact the Companys future
financial results, including the following and those described in Part II, Item
5, Risk Factors and Cautionary Statements:  
    
    We are unable to predict the results of the investigation by the
SEC, the stockholders litigation or the purported class action
litigation filed in Florida.  
    
    Estimates of future financial results are inherently unreliable.  
    
    Our efforts to improve the margins of our ATM Management business may not be successful.  
    
    Consolidation in the industries we serve may adversely affect our
ability to sell our products and services.  
    
    Our ability to expand through acquisitions involves risks and may
not be successful.  
    
    We face intense competition in all areas of our business, and if we
do not compete effectively, our business will be harmed.  
    
    If we experience system failures, the products and services we
provide to our customers could be delayed or interrupted, which could
harm our business and reputation and result in the loss of customers.  
    
    Our sales of IT services have been declining and our largest
IT services contract expires in March 2005.  
    
    Legislation or regulation could harm our ability to collect and use
data, increase our operating costs or otherwise harm our business.  
    
    If the security of our databases is compromised, our reputation
could suffer and customers may not be willing to use our products and
services.  
    
    We may experience software defects, development delays and
installation difficulties, which would harm our business and reputation
and expose us to potential liability.  
    
    There are a number of risks associated with our international sales
and operations that could harm our business.  
    
    Changes in Indian tax laws could adversely affect our results of operations.  
    
    We face termination and compliance risks with respect to our
government contracts and we expect our revenues from this business to
decline in upcoming periods.  
    
    We may be unable to protect our intellectual property rights.  
    
    Provisions in our charter documents and Delaware law may delay or prevent a change in control. 15




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##### Table of Contents









RESULTS OF OPERATIONS

The following table presents our condensed consolidated financial results for
the three and six month periods ended June 30, 2004 and 2003:

Three Months Ended June 30,
    
    Six Months Ended June 30,(dollars in thousands)
    
    2004
    
    2003
    
    % Change
    
    2004
    
    2003
    
    % ChangeNet revenue
    
    $
    140,712
    
    
    $
    132,956
    
    
    
    5.8
    %
    
    $
    281,598
    
    
    $
    263,484
    
    
    
    6.9
    %Operating expenses:Processing, communication
and service costs
    
    
    56,661
    
    
    
    59,939
    
    
    
    (5.5
    )
    
    
    115,331
    
    
    
    115,645
    
    
    
    (0.3
    )Employee costs
    
    
    47,787
    
    
    
    45,084
    
    
    
    6.0
    
    
    
    96,729
    
    
    
    92,013
    
    
    
    5.1Depreciation and amortization
    
    
    9,027
    
    
    
    8,834
    
    
    
    2.2
    
    
    
    17,956
    
    
    
    17,623
    
    
    
    1.9Other operating costs
    
    
    13,108
    
    
    
    12,185
    
    
    
    7.6
    
    
    
    23,431
    
    
    
    24,712
    
    
    
    (5.2
    )Restructuring and provision
for contract loss charges
    
    
    1,253
    
    
    
    
    
    
    
    *
    
    
    
    1,253
    
    
    
    
    
    
    
    *Total operating expenses
    
    
    127,836
    
    
    
    126,042
    
    
    
    1.4
    
    
    
    254,700
    
    
    
    249,993
    
    
    
    1.9Income from operations
    
    
    12,876
    
    
    
    6,914
    
    
    
    86.2
    
    
    
    26,898
    
    
    
    13,491
    
    
    
    99.4Other income (expense)  net
    
    
    585
    
    
    
    616
    
    
    
    (5.0
    )
    
    
    (39
    )
    
    
    860
    
    
    
    *Income before income taxes
    
    
    13,461
    
    
    
    7,530
    
    
    
    78.8
    
    
    
    26,859
    
    
    
    14,351
    
    
    
    87.2Provision for income taxes
    
    
    (4,038
    )
    
    
    (2,417
    )
    
    
    67.1
    
    
    
    (8,057
    )
    
    
    (4,606
    )
    
    
    74.9Net income
    
    $
    9,423
    
    
    $
    5,113
    
    
    
    84.3
    
    
    $
    18,802
    
    
    $
    9,745
    
    
    
    92.9




|* |  | Represents an increase or decrease in excess of 100%.
|- |  | -----------------------------------------------------

Net Revenue

Net revenue by reportable segment and for the Company as a whole for the three
and six month periods ended June 30, 2004 and 2003 was as follows:

Three Months Ended June 30,
    
    Six Months Ended June 30,(in millions)
    
    2004
    
    2003
    
    % Change
    
    2004
    
    2003
    
    % ChangeElectronic PaymentsEFT processing
    
    $
    28.6
    
    
    $
    24.4
    
    
    
    17
    %
    
    $
    54.2
    
    
    $
    49.4
    
    
    
    10
    %Government services (EBT)
    
    
    14.1
    
    
    
    12.7
    
    
    
    11
    
    
    
    28.7
    
    
    
    23.5
    
    
    
    22Software sales
    
    
    9.0
    
    
    
    8.1
    
    
    
    11
    
    
    
    18.5
    
    
    
    15.4
    
    
    
    2051.7
    
    
    
    45.2
    
    
    
    14
    
    
    
    101.4
    
    
    
    88.3
    
    
    
    15Risk ManagementFinancial institution products
    
    
    30.3
    
    
    
    26.5
    
    
    
    14
    
    
    
    60.9
    
    
    
    52.9
    
    
    
    15Retail products
    
    
    4.7
    
    
    
    5.5
    
    
    
    (15
    )
    
    
    9.3
    
    
    
    11.1
    
    
    
    (16
    )35.0
    
    
    
    32.0
    
    
    
    9
    
    
    
    70.2
    
    
    
    64.0
    
    
    
    10ATM Management
    
    
    34.6
    
    
    
    36.3
    
    
    
    (5
    )
    
    
    69.7
    
    
    
    70.2
    
    
    
    (1
    )Global OutsourcingBPO
    
    
    12.9
    
    
    
    9.4
    
    
    
    37
    
    
    
    26.0
    
    
    
    19.6
    
    
    
    33IT services
    
    
    6.5
    
    
    
    10.0
    
    
    
    (35
    )
    
    
    14.3
    
    
    
    21.4
    
    
    
    (33
    )19.4
    
    
    
    19.4
    
    
    
    
    
    
    
    40.3
    
    
    
    41.0
    
    
    
    (2
    )Total net revenue
    
    $
    140.7
    
    
    $
    133.0
    (1)
    
    
    6
    
    
    $
    281.6
    
    
    
    263.5
    
    
    
    7  (1)
    
    Amount
does not sum due to rounding. Electronic Payments The increase in the Electronic Payments segment revenues during the three
months ended June 30, 2004 as compared to the same period in 2003 is primarily
due to:  
    
    a 17% increase in EFT processing revenues caused by higher
processing volumes and  
    
    an 11% increase in revenues from EBT processing as a result
of new contracts that commenced during the second quarter of 2003. During the six months ended June 30, 2004, government services revenues increased 22% as a result of the full period effect of EBT contracts that commenced
during the first half of 2003. Processing revenues from financial institution
customers increased 10% during the first half of 2004 as compared
to the same period in 2003 due primarily to higher transaction volumes. 16




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##### Table of Contents



Software revenues increased during the three and six month periods ended June
30, 2004 as compared to the same periods ended 2003 due to open
systems
software sales attributable to our acquisition of Oasis Technology Ltd. last
fall. The following table illustrates the revenue we
generated from software sales during the periods indicated. In conjunction with our enhanced segment revenue presentation,
we have classified customer reimbursed network fees within the related
product lines within the Electronic Payments and Global Outsourcing
segments. Amounts in prior periods have been reclassified to conform
with this presentation. Three Months Ended
    
    Six Months EndedJune 30
    
    June 30(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003License fees
    
    $
    1,913
    
    
    $
    2,536
    
    
    $
    3,877
    
    
    $
    4,271Maintenance
    
    
    5,077
    
    
    
    3,638
    
    
    
    10,304
    
    
    
    7,403Software services
    
    
    2,059
    
    
    
    1,889
    
    
    
    4,342
    
    
    
    3,775$
    9,049
    
    
    $
    8,063
    
    
    $
    18,523
    
    
    $
    15,449
 We expect the total revenues
from our Electronic Payments segment to be higher in 2004 as compared
to 2003 due to increased volumes from our existing financial
institution processing customers, our success in securing new
financial institution customers and higher software sales from
incremental revenue provided by an acquisition we closed last
November. We expect, however, that this increase will be partially
offset by a decline in our legacy software sales in the United
States. Although we continue to pursue new EBT contracts, we cannot
predict whether our bids will be successful and, in any event, we
expect the revenues we receive from EBT activities to decline during
the remainder of 2004 due to scheduled contract expirations. We
expect this trend to continue during 2005. Risk Management During the three and six
month periods ended June 30, 2004, our financial institution
product revenues increased 14% and 15%, respectively, as compared to the same periods
in 2003 primarily due to higher ChexSystems(SM) transaction volumes associated with new debit
account openings. These increases were offset
somewhat by a decline in our retail revenues of 15% and 16% for the
quarter and six month periods ended June 30, 2004, respectively,
as compared to the same periods in 2003 primarily from our SCAN(SM)
product. We expect revenues from our
Risk Management segment to increase in 2004 as compared to 2003 due primarily
to increased demand for our financial institution products and services.
Revenues from our SCAN(SM) product line are expected to increase
modestly during the balance of 2004 as compared to the first half of
the year. ATM Management The decrease in the revenues we received from our ATM business during the three
month period ended June 30, 2004 as compared to the same period in 2003 is
primarily due to a general decline in transaction volumes in the second quarter
of 2004. We believe our experience is consistent with industry trends.
Equipment sales also declined during the second quarter of 2004 as compared to
the same quarter in 2003. These declines were partially offset by an increase
in branding revenues. The decline in ATM revenues for the six month period
ended June 30, 2004 as compared to the same period ended 2003 is primarily due
to lower equipment sales. We continue to direct the ATM business towards
expanding its offerings of end-to-end ATM portfolio management services as well
as branding services to financial institutions. We expect a modest increase in
revenues during the second half of 2004 as compared to the first half of 2004
from sales of branding and surcharge free access services, managed services and
sales of equipment and software upgrades mandated by regional and network
associations. Global Outsourcing The revenues from our outsourcing business during the three and six months
ended June 30, 2004 were relatively flat as compared to the same periods in
2003 because the revenue increases generated from increased BPO service volumes
were offset by declines in IT service revenues. We are focused on
obtaining revenue growth in our BPO business through new client relationships
and through an expansion of the services provided to our existing
clients. For the full year 2004, we expect net revenue from our
Global Outsourcing segment will increase modestly as compared to 2003
from continued growth in our BPO business because we believe this
growth will exceed the IT services revenue declines we expect during
the balance of the year. 17




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##### Table of Contents



Business Segment Margin Contributions The following table presents our operating income (loss) by segment and total
operating income for the three and six month periods ended June 30, 2004 and
2003: Three Months Ended June 30,
    
    Six Months Ended June 30,(dollars in thousands)
    
    2004
    
    2003
    
    % Change
    
    2004
    
    2003
    
    % ChangeOperating income (loss)Electronic payments
    
    $
    7,387
    
    
    $
    9,268
    
    
    
    (20.3
    )%
    
    $
    15,415
    
    
    $
    18,394
    
    
    
    (16.2
    )%Risk management
    
    
    12,444
    
    
    
    6,558
    
    
    
    89.8
    
    
    
    24,217
    
    
    
    13,029
    
    
    
    85.9ATM management
    
    
    446
    
    
    
    657
    
    
    
    (32.1
    )
    
    
    720
    
    
    
    219
    
    
    
    *Global outsourcing
    
    
    3,048
    
    
    
    748
    
    
    
    *
    
    
    
    7,090
    
    
    
    2,168
    
    
    
    *Corporate
    
    
    (10,449
    )
    
    
    (10,317
    )
    
    
    (1.3
    )
    
    
    (20,544
    )
    
    
    (20,319
    )
    
    
    (1.1
    )Total operating income
    
    $
    12,876
    
    
    $
    6,914
    
    
    
    86.2
    
    
    $
    26,898
    
    
    $
    13,491
    
    
    
    99.4
  *
    
    Represents an increase or decrease in excess of 100%. Electronic Payments The decline in margins during
the three and six month periods ended June 30, 2004 as compared
to the same periods in 2003 is primarily due to an increase in our
fixed costs associated with our acquisition of Oasis Technology last
November. Approximately $1.2 million of restructuring and provision for
contract loss charges also contributed to the decline in margins. Increases in
revenues from our EFT and EBT processing services reduced the impact of these
losses. Consistent with our experience during the first half of 2004,
we expect the operating margins for the Electronic Payments segment
for the balance of 2004 to be below those seen in 2003, due to the diminished performance of our software
business and the impact of a $3.7 million reversal of the provision for
government service loss contracts we recorded in 2003. We do not expect to
record a similar reversal in 2004. We are actively seeking to reduce the
expenses associated with our open systems software product line, as reflected by the
$0.8 million severance related restructuring charge we recorded during the
second quarter of 2004. Risk Management Our Risk Management segment experienced higher margins during the three and six
months ended June 30, 2004 as compared to the same periods in 2003 primarily
because the increase in ChexSystem(SM) revenues was spread over a relatively
fixed cost structure. Our risk management business also improved margins by
reducing costs through the utilization of our India operations for contact
center and software development work. The margins for our Risk Management
segment are expected to be higher in 2004 as compared to 2003 as a result of
our efforts to reduce its operating costs and the higher transaction volumes we
anticipate for our ChexSystem(SM) products. ATM Management During the three months ended June 30, 2004, our ATM business experienced a
decrease in margins primarily due to a decline in revenues resulting from lower
transaction volumes. The increase in margins during the six months ended June
30, 2004 as compared to the same period in 2003 is primarily due to cost
reduction efforts. We are evaluating a number of options to improve
the returns on our investment in this business, including efforts directed towards increasing our sales of ATM management and
branding services to large retailers and financial institutions as well as
improving the cost structure of this business. We expect margins from this
business to improve moderately in 2004 as compared to 2003. Global Outsourcing Margins for our global outsourcing business improved during the three and six
months ended June 30, 2004 as compared to the same periods in 2003 primarily
due to increased productivity, capacity utilization and certain non-recurring
revenues specific to the second quarter. We expect that margins in this
business will decline somewhat during the balance of 2004 as compared to the
first half of the year because of additional fixed costs associated with the
opening of a new facility in India and lower revenues due to seasonal factors.
We anticipate that shortfall fees under our primary IT Services
contract will be recognized in the fourth quarter, somewhat
offsetting these factors. Corporate Unallocated corporate overhead includes, among other things, executive
leadership costs, investor relations, general legal, consulting and accounting
and finance costs and certain technology costs. Corporate expenses remained
relatively flat during the three and six months ended June 30, 2004 as compared
to the same periods in 2003. 18




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##### Table of Contents



Corporate overhead costs incurred for the second half of 2004 are expected to
be generally consistent with the costs incurred during the first half of 2004. Operating Expenses Operating expenses for the three and six months ended June 30, 2004 and 2003
were as follows: Three Months Ended June 30,
    
    Six Months Ended June 30,(dollars in thousands)
    
    2004
    
    2003
    
    % Change
    
    2004
    
    2003
    
    % ChangeOperating expenses:Processing,
communication and
service costs
    
    $
    56,661
    
    
    $
    59,939
    
    
    
    (5.5
    )%
    
    $
    115,331
    
    
    $
    115,645
    
    
    
    (0.3
    )%Employee costs
    
    
    47,787
    
    
    
    45,084
    
    
    
    6.0
    
    
    
    96,729
    
    
    
    92,013
    
    
    
    5.1Depreciation and
amortization
    
    
    9,027
    
    
    
    8,834
    
    
    
    2.2
    
    
    
    17,956
    
    
    
    17,623
    
    
    
    1.9Other operating costs
    
    
    13,108
    
    
    
    12,185
    
    
    
    7.6
    
    
    
    23,431
    
    
    
    24,712
    
    
    
    (5.2
    )Restructuring and
provision for contract
loss charges
    
    
    1,253
    
    
    
    
    
    
    
    *
    
    
    
    1,253
    
    
    
    
    
    
    
    *Total operating expenses
    
    $
    127,836
    
    
    $
    126,042
    
    
    
    1.4
    
    
    $
    254,700
    
    
    $
    249,993
    
    
    
    1.9
 * Represents an increase or decrease in excess of 100%. Processing, communication and service costs This category includes the cost of transaction processing, telecommunications,
computer equipment and promotional services. This category also includes the
residual payments we make to the occupants of the properties where the ATMs
that we own or manage are located. Processing, communication and service costs decreased during the three months
ended June 30, 2004 as compared to the same period ended 2003 primarily due to
decreases in costs related to outside processing fees, decreases in costs of
ATM equipment sales and a decrease in the fees associated with certain
equipment leases. Processing, communication and service costs during the six
months ended June 30, 2004 were consistent with the costs incurred during the
same period in 2003 as decreases in the costs associated with outside
processing and equipment sales were offset by higher network fees. Processing,
communication and service costs are expected to increase in 2004 as compared to
the prior year in conjunction with the anticipated increase in transaction
volumes. Employee costs Employee compensation, payroll taxes and medical expenses increased during the
three and six month periods ended June 30, 2004 as compared to the same periods
in 2003 primarily due to increases in our India-based employee headcount and
performance-based compensation expenses. These increases were partially offset
by savings on compensation resulting from business improvement initiatives
undertaken in 2003. Company-wide headcount decreased approximately 100 to
5,500 at June 30, 2004 from the first quarter of 2004 primarily due to the
results of planned restructuring activities. Company-wide headcount has
increased approximately 300 since December 31, 2003 primarily due to our
acquisition activity and growth in our BPO business. At June 30, 2004,
approximately 71% of our employees were located in India. We expect employee
costs to increase during the remainder of 2004 as compared to the latter half
of 2003 because of the increased headcount needed to support anticipated
business growth and increased accruals related to our performance-based
compensation plans. Depreciation and amortization These costs represent the depreciation of our facilities and equipment and the
amortization of intangible assets, such as capitalized software costs and
acquired contracts. Depreciation and amortization expenses during the three and
six months ended June 30, 2004 were consistent with the level of such expenses
recorded during the same periods in 2003. We expect depreciation and
amortization costs to be higher for the full year 2004 as compared to 2003 due
to the additional amortization costs related to the assets we acquired in 2004
and the effects of a full year of depreciation and amortization related to the
assets we acquired in late 2003. Other operating costs Expenditures in this category include facilities costs, professional,
consulting and temporary services, bad debt write-offs and certain
administrative costs. The increase in other operating costs during the second
quarter of 2004 as compared to the same quarter in 2003 is primarily due to an
increase in legal costs associated with the Securities 19




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##### Table of Contents



and Exchange Commission (SEC) investigation and litigation expense. Other
operating costs during the six months ended June 30, 2004 decreased as compared
to the same period in 2003 primarily due to a reduction in external consulting
costs incurred to support our strategic planning process. We expect to
continue to incur expenses for legal services associated with the SEC
investigation and outstanding litigation, for external consultants related to
the business improvement initiatives we commenced in early 2003 and for costs
related to compliance with Section 404 of the Sarbanes-Oxley Act. Restructuring charge and provision for contract losses During the three months ended
June 30, 2004, primarily we incurred approximately $0.8
million of restructuring charges in severance benefits for approximately 35
employees primarily supporting our open-systems software product line. We continue to
seek opportunities to reduce employee costs as part of our ongoing business
improvement initiatives. During the second quarter of 2004, we recorded a $0.5 million provision for
contract loss charge for certain long-term software contracts. These contracts
require significant modification to the underlying software and the revenue
associated with the contracts was recognized using the percentage-of-completion
method, which relies on estimates of total expected contract costs. Unexpected
increases in the scope of these projects resulted in unanticipated increases in
the expense required to perform the contracts with the result that we now
expect to incur losses in the performance of these contracts. The losses
recorded are based on our best current estimates of the contracts ultimate
revenues and expenses. Actual results may differ from our estimates. In the
event such differences arise, a revision to the loss reserve would be required. Other income (expense) - net Other income (expense) - net primarily includes interest and investment income
that is enhanced or reduced by gains and losses on the disposal of assets,
interest and investment expense and foreign currency translation adjustments.
Interest earned on cash and cash equivalents was $0.4 million and $0.9 million
for the three and six month periods ended June 30, 2004, respectively, as
compared to $0.7 million and $1.2 million for the same periods in 2003
respectively. Other income remained relatively flat in the second quarter of
2004 as compared to the same quarter in 2003. The other income we recorded
during the first six months of 2003 changed to other expense during the
comparable period of 2004 due to the impact of unfavorable foreign currency
translation adjustments incurred during the first quarter of 2004. Provision for income taxes Our annualized effective tax rates for the three and six months ended June 30,
2004 were 30.0% as compared to 32.1% for the same periods in 2003. Our
effective tax rate is largely determined by our Indian subsidiarys
proportional share of our projected consolidated income. Our Indian software
development and business process outsourcing operations qualify for tax
incentives associated with businesses that operate within designated geographic
locations in India. These incentives generally provide us with exemptions from
Indian income tax on certain business income generated from these operations
and phase out through March 2009. We are currently performing an analysis to
determine if we are eligible for certain tax credits and other benefits which
may result in possible beneficial adjustments to our tax rate. The amount,
timing and likelihood of any such benefits cannot be currently determined. LIQUIDITY AND CAPITAL RESOURCES Overview Information about our financial position as of June 30, 2004 and December 31,
2003 is presented below: June 30,
    
    December 31,(dollars in thousands)
    
    2004
    
    2003
    
    % ChangeCash and cash equivalents
    
    $
    174,942
    
    
    $
    158,106
    
    
    
    10.6
    %Long-term debt due within one year
    
    
    2,264
    
    
    
    5,586
    
    
    
    (59.5
    )Long-term debt
    
    
    3,692
    
    
    
    1,667
    
    
    
    *Stockholders equity
    
    
    429,891
    
    
    
    401,662
    
    
    
    7.0Net working capital
    
    
    187,939
    
    
    
    162,702
    
    
    
    15.5
 * Represents an increase or decrease in excess of 100%. 20




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##### Table of Contents



Cash Resources We expect our beginning cash balance and cash provided from operations in
future periods to be sufficient to meet our normal operating commitments and to
fund planned capital expenditures and complementary acquisitions. Cash and
cash equivalents at June 30, 2004 included cash in ATMs of approximately $6
million and cash in India of approximately $12 million. The funds in India are
held in Indian bank accounts denominated in Indian rupees or U.S. dollars.
These funds are available for use in our Indian operations and investments. We
consider these funds to be permanently invested and have no current intention
of repatriating them to the United States. As part of our transaction processing business, we provide cash settlement
services to financial institutions and state and local governments. These
services involve the movement of funds between the various parties associated
with an ATM, point-of-sale or EBT transaction and this activity results in a
balance due to us at the end of each business day that we recoup over the next
few business days. The balances due us are included in cash and cash
equivalents on our consolidated balance sheets. As of June 30, 2004,
approximately $29 million of settlement payments were due to us and we
received these funds in early July 2004. We are required to maintain sufficient
cash on hand to fund the daily settlement advances we make against the payments
we receive through the settlement process. The typical overnight settlement
balance due to us ranges from $5 million to $30 million. We also seek to
maintain an additional cash balance of approximately $35 million to ensure that
we can advance funds to our processing customers if unusual circumstances
prevent us from processing their settlement files in a timely fashion. We are
considering an overnight credit facility to fund these potential obligations. We have vault cash agreements with various financial institutions that provide
cash to certain of the ATMs owned or managed by us. Although some portion of
this cash may be physically located in the ATMs that we own or manage, these
funds are not included in cash and cash equivalents on our consolidated balance
sheet because we do not take title to it under the bailee/bailor relationship
as established by the agreements. Based upon the daily outstanding balance of
funds provided to the ATMs, we generally pay a monthly fee ranging from prime,
as defined, plus one half percent up to prime plus 5%. The average monthly rate
paid during the six months ended June 30, 2004 approximated 7%. We indemnify
the financial institutions against any loss of the vault cash in the ATMs. Two
of the agreements require us to maintain a security deposit equal to 1% of the
daily outstanding balance. These agreements may be terminated upon notice by
either party and have various expiration dates through June 2005. Cash provided
at June 30, 2004 and December 31, 2003 pursuant to agreements with third-party
vault cash providers was approximately $33 million and $41 million,
respectively. The following table sets forth our contractual cash obligations as of June 30,
2004 in total and for the time periods specified. Our long-term debt consists
principally of capital lease obligations related to purchased software and
equipment. Payments Due by PeriodSix-months
    
    Three Years
    
    Three Yearsended
    
    ended
    
    endedDecember 31,
    
    December 31,
    
    December 31,(in thousands)
    
    Total
    
    2004
    
    2007
    
    2010
    
    ThereafterCapital lease obligations
    
    $
    5,956
    
    
    $
    1,590
    
    
    $
    3,625
    
    
    $
    741
    
    
    $
    Operating lease
obligations1
    
    
    56,236
    
    
    
    6,265
    
    
    
    24,931
    
    
    
    17,267
    
    
    
    7,773Vendor obligations
    
    
    68,842
    
    
    
    20,027
    
    
    
    48,815
    
    
    
    
    
    
    
    Total
    
    $
    131,034
    
    
    $
    27,882
    
    
    $
    77,371
    
    
    $
    18,008
    
    
    $
    7,773
  1
 For the purposes of this table, contractual obligations for purchases of
services are defined as agreements that are enforceable and legally binding and
that specify all significant terms, such as fixed or minimum quantities to be
purchased, fixed, minimum or variable price provisions and the approximate
timing of the transaction. Purchase orders for goods and services are not
included in this table. Our purchase orders may represent authorizations to
purchase rather than binding agreements. These orders are based upon our
current service needs and are generally fulfilled by our vendors within one or
two months. We are party to certain other contracts with third parties whereby the third
party provides services to us. These services are operational in nature and our
obligations under these contracts vary from period to period based on our 21




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utilization of the services. These commitments are not reflected in the table
above as the associated amounts are not currently determinable. Sources and Uses of Cash The following table sets forth a summary of our cash flow activity for the six
months ended June 30, 2004 and 2003. This table should be read in conjunction
with our condensed consolidated statements of cash flows: Summary of Cash FlowsFor the Six MonthsEnded June 30,(in thousands)
    
    2004
    
    2003Cash provided by operating activities
    
    $
    30,806
    
    
    $
    36,324Cash (used in) provided by investing
activities
    
    
    (18,010
    )
    
    
    770Cash provided by (used in) financing
activities
    
    
    4,040
    
    
    
    (303
    )Net increase in cash and cash equivalents
    
    $
    16,836
    
    
    $
    36,791
 Our current priorities for use of our cash are:  
    
    investment in projects intended to increase our product delivery
and operational effectiveness, enhance our product suite and the
redundancy of our systems;  
    
    complementary acquisitions; and  
    
    ensuring we can fund our settlement obligations. We do not currently anticipate using our funds to pay cash dividends or
repurchase our stock. Operating Activities Our primary source of liquidity is the profits we generate from our business.
Operating cash outflows include payments to vendors for processing and
telecommunications services, consulting services and supplies. We also pay
salaries and benefits to our employees and income taxes. Performance-based bonuses paid during the first quarter of 2004 resulted in a
cash outflow of approximately $13.9 million. Cash flow from operations also
decreased due to an increase in accounts receivable related to annual software
maintenance billing and extended receivables related to our recently acquired
EFT software business. These decreases were offset by an increase in cash flows
associated with our positive operating results. Investing Activities Cash used in or provided by our investing activities generally reflects the
sale or acquisition of assets. During the first six months of 2004, we
disbursed approximately $6.1 million for our acquisitions of Penley, LCS and
Benton Consulting Partners and approximately $11.4 million to purchase fixed
assets and develop software. Financing Activities We receive funds from the exercise of stock options and the sale of our shares
through our employee stock purchase plan. Financing outflows generally include
the repayment of debt. During the six months ended June 30, 2004, we used cash
to repay debt of approximately $4.2 million and we received approximately $8.2
million in proceeds from the exercise of stock options and the sale of shares
through our employee stock purchase plan. Commercial Commitments The following table sets forth our future commercial commitments as of June 30,
2004: Commitment Expiration by Period*(in thousands)
    
    Total
    
    2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    ThereafterLetters of credit and other
    
    $
    1,684
    
    
    $
    790
    
    
    $
    880
    
    
    $
    14
    
    
    $
    
    
    
    $
    
    
    
    $
    Guarantees
    
    
    638
    
    
    
    8
    
    
    
    172
    
    
    
    302
    
    
    
    140
    
    
    
    16
    
    
    
    Performance bonds
    
    
    14,156
    
    
    
    2,640
    
    
    
    11,351
    
    
    
    120
    
    
    
    45
    
    
    
    
    
    
    
    Total commitments
    
    $
    16,478
    
    
    $
    3,438
    
    
    $
    12,403
    
    
    $
    436
    
    
    $
    185
    
    
    $
    16
    
    
    $
    
  *
    
    Represents commercial commitment expirations during the six months ended
December 31, 2004, during the respective years ended December 31, 2005
through 2008 and thereafter. 22




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Prior to our acquisition of Access Cash International, L.L.C. (ACI) in 2001, we
had committed to guarantee up to approximately $1.8 million of equipment lease
payments for Canadian customers of our ATM management business and as of June
30, 2004, were guaranteeing lease payments amounting to approximately $0.6
million. Through June 30, 2004, we have been required to make payments of $0.3
million pursuant to these guarantees. We use cash collateral to secure letters of credit we issue in the ordinary
course of business. We had $1.2 million in letters of credit outstanding at
June 30, 2004, mostly related to leases. These letters of credit were secured
by $1.4 million in cash collateral. We have also pledged $0.5 million of time
deposits as collateral related to the guarantee of performance on a customer
contract and certain obligations related to local government requirements. In connection with our government services business, collection and ATM
placement activities, we post surety bonds with state agencies guaranteeing our
performance of certain obligations related to the relevant contracts or state
requirements. The aggregate amount of such bonds outstanding at June 30, 2004
was $14.2 million. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The discussion and analysis of our financial condition and results of
operations is based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles that are generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates and judgments, including those related to revenue recognition,
intangible assets, reserves and allowances, income taxes and stock-based
compensation. We base our estimates on our historical experience and on various
other assumptions that we believe to be reasonable under the circumstances. The
results of these estimates form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. There were no significant changes in our critical
accounting policies during the first six months of 2004. These policies are
described in our Annual Report on Form 10-K for the period ending December 31,
2003. Recent Accounting Pronouncements In December 2003, the FASB revised FIN No. 46, Consolidation of Variable
Interest Entities (FIN 46R), which addresses how a business enterprise should
evaluate whether it has a controlling financial interest in an entity through
means other than voting rights and accordingly should consolidate the entity.
FIN 46R replaces FIN No. 46, Consolidation of Variable Interest Entities,
which was issued in January 2003. FIN 46R is required for all enterprises with
variable interests in variable interest entities (VIEs) created after December
31, 2003. For variable interests in VIEs created before January 1, 2004, FIN
46R will be applied beginning on January 1, 2005, with effective dates for
public enterprises varying based on the type of VIE, whether the public
enterprise is a small business issuer, and whether the original interpretation
issued in January 2003 was applied to a VIE prior to the effective date of FIN
46R. For any VIEs that must be consolidated under FIN 46R that were created
before January 1, 2004, the assets, liabilities and noncontrolling interests of
the VIE initially would be measured at their carrying amounts with any
difference between the net amount added to the balance sheet and any previously
recognized interest being recognized as the cumulative effect of an accounting
change. If determining the carrying amounts is not practicable, fair value at
the date FIN 46R first applies may be used to measure the assets, liabilities
and noncontrolling interest of the VIE. The adoption of FIN 46R did not have an
impact on our condensed consolidated financial position or results of
operations. FORWARD-LOOKING STATEMENTS  In addition to historical and pro forma information, this Quarterly Report
contains forward-looking statements as defined in the U.S. Private Securities
Litigation Reform Act of 1995. All forward-looking statements are subject to
various risks and uncertainties that could cause actual results to differ
materially from those described in the statements. Some of the factors that
could cause actual results to differ from those that are presently anticipated
are discussed in Part II, Item 5 of this Quarterly Report. The Company expects that full year net revenues for 2004 will increase
approximately 5 to 10 percent over the net revenues recorded in 2003 of
approximately $532.1 million. Additionally, the Company expects full year
diluted 23




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earnings per share to increase 25 to 30 percent in 2004 over the diluted
earnings per share of $0.61 reported in 2003. The Company expects to generate
operating cash flows in 2004 in line with the level achieved in 2003. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We operate internationally and are subject to potentially adverse movements in
foreign currency exchange rates. These exposures may change over time as our
business evolves and could have an adverse impact on our financial results. We
have not entered into any derivative instruments or hedging contracts to reduce
our exposure to adverse foreign currency or interest rate changes, although we
may do so in the future. Currently, we receive non-U.S. dollar denominated
revenues and incur non-U.S. dollar denominated operating expenses in the United
Kingdom, India and Canada. We also have assets located in these countries. The
principal currencies creating foreign exchange rate risk for us are the British
pound, Indian rupee and Canadian dollar. For the three and six months ended
June 30, 2004, approximately 7% and 8% of our net revenues, respectively, and
approximately 15% and 17% of our operating expenses, respectively, were
denominated in these three currencies. We have prepared sensitivity analyses to assess the impact of hypothetical
changes in foreign currency rates on our income before tax for the three and
six months ended June 30, 2004. Based upon these analyses, we estimate that a
10% adverse change in the exchange rate between the U.S. dollar and the British
pound, Indian rupee and Canadian dollar would have reduced our reported income
before taxes in the three and six month periods ended June 30, 2004 by
approximately $1 million and $3 million, respectively. A 10% change in the
exchange rate for the British pound, Indian rupee and Canadian dollar would
also have an impact on the foreign net assets reflected in our balance sheet,
but we would not expect this change to be material to our total assets. Changes in interest rates could impact our anticipated interest income on cash
equivalents and interest expense on variable short-term debt. A 10% adverse
change in interest rates from the interest rates in effect at the end of June
30, 2004 would not, however, have had a material adverse effect on our net
income or financial condition for the three or six month periods ended June 30,
2004. 
 ITEM 4. CONTROLS AND PROCEDURES The Companys management, under the supervision and with the participation of
its Chief Executive Officer and Chief Financial Officer, evaluated the
Companys disclosure controls and procedures as of June 30, 2004. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that these disclosure controls and procedures are effective. There
have been no significant changes in the internal controls related to
financial reporting that have materially affected, or are reasonably likely to
materially affect, these controls since June 30, 2004. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS Reference is made to the discussion of the SEC investigation, the Federal
Securities Action, the Shareholder Derivative Actions, and the Florida
litigation discussed in Notes 11 and 12 to the Financial Statements included in
this Quarterly Report on Form 10-Q. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its annual stockholders meeting on May 20, 2004. 42,687,316
shares were represented at the meeting, constituting 89.3% of the shares
outstanding and eligible to vote. Two items were considered at the meeting and
the results of the voting were as follows: Proposal 1. To Elect two Nominees to the Board of Directors: Nominee
    
    For
    
    WithheldRichard J. Almeida
    
    
    41,788,163
    
    
    
    899,153Sheila A. Penrose
    
    
    41,788,963
    
    
    
    898,353
 24




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##### Table of Contents



The terms of office of our directors John J. (Jack) Boyle III, Janet M. Clarke,
Robert C. Nakasone, Hatim A. Tyabji and Paul F. Walsh also continued after the
meeting. Proposal 2. To ratify the selection of KPMG LLP as the Companys independent
auditors for the fiscal year ending December 31, 2004: For
    
    Against
    
    Abstain42,186,547
    
    
    471,349
    
    
    
    29,420
 
 ITEM 5. OTHER INFORMATION RISK FACTORS AND CAUTIONARY STATEMENTS. When used in this Quarterly Report on Form 10-Q and in future filings by the
Company with the Securities and Exchange Commission, in our press releases,
letters and reports to stockholders and in oral statements made by our
representatives, the words or phrases should result, are expected to,
targeted, will continue, will approximate, is anticipated, estimate,
project or similar expressions are intended to identify forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are necessarily subject to certain risks and
uncertainties, including those discussed below, which could cause our actual
results to differ materially from our historical experience and our present
expectations or projections. Caution should be taken not to place undue
reliance on any such forward-looking statements, which speak only as of the
date made. The factors listed below could affect our financial performance and
could cause our actual results for future periods to differ from any opinions
or statements expressed with respect thereto. Such differences could be
material and adverse. We will not undertake and specifically decline any
obligation to publicly release the result of any revisions that may be made to
any forward-looking statements to reflect events or circumstances occurring
after the date of such statements or to reflect the occurrence of anticipated
or unanticipated events. WE ARE UNABLE TO PREDICT THE RESULTS OF THE INVESTIGATION BY THE SEC AND THE
STOCKHOLDERS LITIGATION. The Company is currently the subject of an investigation by the Securities and
Exchange Commission (the SEC) with respect to restatements of its prior period
financial statements that occurred in 2002. The Company has been cooperating
fully with the SEC staff and intends to continue to do so. The Company may,
however, become subject to a fine or other remedies in connection with the
investigation. The Company has incurred, and may continue to incur,
significant legal expenses in connection with this investigation and the
findings and outcomes of the SEC investigation may affect the course of the
Federal Securities Action and the Shareholder Derivative Actions described
below. The Company, its former chief executive and chief financial officers and its
current chief financial officer were defendants in a federal securities action
(the Federal Securities Action) that was pending in the U.S. District Court for
the District of Arizona. The Consolidated Amended Complaint (Complaint) filed
in this Action alleged, among other things, that during the period from July
21, 2000 through October 24, 2002 the defendants made false and misleading
statements and omissions of material facts and that the plaintiff and other
members of a putative class of shareholders suffered damages as a result. This
Complaint was dismissed by order of the Court on July 12, 2004. The Company is also a nominal defendant in two substantially identical
shareholder derivative actions filed in the Superior Court of Arizona, Maricopa
County in January 2003 (the Shareholder Derivative Actions). The complaints in
these actions allege, among other things, that certain of the Companys current
and former directors named in the complaints as defendants breached their
fiduciary duties to the Company in connection with certain alleged issues
involving the Companys accounting practices and internal controls. The
complaints also name as a defendant the Companys former external auditor.
These actions were stayed pending the resolution of the motion to dismiss the
Federal Securities Action and the defendants
are now evaluating how to proceed in this litigation in light of the
ruling in the Federal Securities Litigation. The Company believes the Shareholder Derivative Actions are without merit and
intends to vigorously defend itself. However, the Company cannot predict the
outcome of these actions with certainty. We may incur significant legal
expense in connection with the defense of these claims. 25




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In addition, the Companys insurance carriers may decline coverage, or the
coverage may be insufficient to cover the Companys expenses and liability, in
some or all of the matters. At this time, it is not possible to estimate the
amount of loss or probable losses, if any, that might result from an adverse
resolution of these matters. ESTIMATES OF FUTURE FINANCIAL RESULTS ARE INHERENTLY UNRELIABLE. From time to time, the Company and its representatives may make public
predictions or forecasts regarding the Companys future results, including
estimates regarding future revenues, expense levels, tax rates, capital
expenditures, earnings or earnings from operations. Any forecast regarding our
future performance reflects various assumptions. These assumptions are subject
to significant uncertainties, and, as a matter of course, many of them will
prove to be incorrect. Further, the achievement of any forecast depends on
numerous factors, including the considerations specific to our business that
are outlined in this discussion as well as general economic and geopolitical
trends that can adversely affect the market for our products and services. Many
of the factors that can adversely affect our business are beyond our control.
As a result, there can be no assurance that our performance will be consistent
with any management forecasts or that the variation from such forecasts will
not be material and adverse. Investors are cautioned not to base their entire
analysis of our business and prospects upon isolated predictions, but instead
are encouraged to utilize the entire available mix of historical and
forward-looking information made available by us, and other information
relating to our Company and our products and services, when evaluating our
prospective results of operations. OUR EFFORTS TO IMPROVE THE MARGINS OF OUR ATM MANAGEMENT BUSINESS MAY NOT BE
SUCCESSFUL. Our ATM Management segment operates one of the largest networks of off-premise
ATMs in North America. For the six months ended June 30, 2004, this business
segment contributed revenues of $69.7 million, or 25% of our total revenues, at
an operating margin of 1.0%. Our strategy to improve margins of this business is directed towards providing
end-to-end ATM management services to financial institutions and retailers. We
believe that effectively changing the focus of this business should allow us to
improve on its historical returns. We also expect improvement in our ATM
business to come from cost reduction efforts and additional revenues from
branding and other value-added services. If we are not successful in our efforts to improve the revenues and
profitability of our ATM business, our future results of operations will be
adversely affected. In any event, our experience indicates that the sales
cycle associated with our efforts to redirect the focus of this business is
lengthy. CONSOLIDATION IN THE INDUSTRIES WE SERVE MAY ADVERSELY AFFECT OUR ABILITY TO
SELL OUR PRODUCTS AND SERVICES. Mergers, acquisitions and personnel changes at financial institutions and
electronic funds transfer networks may adversely affect our business, financial
condition and results of operations. Currently, the banking and EFT industries
are consolidating, causing the number of financial institutions and processing
networks to decline. This consolidation could cause us to lose:  -
    
    current and potential customers;-
    
    market share if an entity resulting from a combination of our
customers determines that it is more efficient to develop in-house
products and services similar to ours or to use our competitors
products and services; and-
    
    revenue if such a combined institution is able to negotiate a
greater volume discount for, or discontinue the use of, our products
and services. For example, J.P. Morgan Chase and Bank One, both of which utilize our risk
management products, have recently merged. Similarly, the STAR network,
formerly one of the larger customers of our electronic payments processing
business, was purchased by one of our competitors, Concord EFS, during 2001.
First Data Corporation, which owned a substantial equity interest in the NYCE
Network, has now purchased Concord EFS. Following this acquisition, First Data
sold its interest in the NYCE network to our competitor, Metavante, a
subsidiary of M&I Bank. Both the STAR and NYCE networks utilize our electronic
funds transfer software. 26




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OUR ABILITY TO EXPAND THROUGH ACQUISITIONS INVOLVES RISKS AND MAY NOT BE
SUCCESSFUL. We are currently considering possible acquisitions to complement and grow our
existing businesses. Our ability to expand through acquisitions involves many
risks, including:  -
    
    the operations, technology and personnel of any acquired
companies may be difficult to integrate;-
    
    the allocation of management resources to consummate these
transactions may disrupt our day to day business;-
    
    the acquired businesses may not achieve anticipated revenues,
earnings or cash flow. Such a shortfall could require us to write-down
the goodwill associated with any acquired company, which would
adversely affect our reported earnings; and-
    
    acquisitions may require us to record special charges that reduce
our earnings, such as the $1.5 million charge we recorded in 2003 to
write-off in-process research and development in connection with our
acquisition of Oasis Technologies Ltd. WE ARE UNABLE TO PREDICT THE RESULTS OF THE PURPORTED CLASS ACTION LAWSUIT
FILED IN FLORIDA. The Company, along with numerous other defendants, is a defendant in an action
pending in the U.S. District Court for the Southern District of Florida. The
complaint in this action alleges that the Company purchased motor vehicle
records from the State of Florida and used that data for marketing and other
purposes that are not permitted under the Federal Drivers Privacy Protection
Act. The plaintiffs are seeking liquidated damages of not less than $2,500 for
each affected member of a purported class, plus costs and attorneys fees. The
plaintiffs are also asking for injunctive relief to prevent further alleged
violations of the Federal Act. On March 11, 2004, the Company
joined in a motion to dismiss this case filed by a co-defendant and
the Company filed its own further motion to dismiss a portion of this
case on June 23, 2004. On June 25, 2004 the Company filed a
motion for summary judgment. All these motions are pending before the
Court. The Company cannot predict whether the plaintiffs in
this case will be successful in certifying their complaint as a class action.
The Company believes that it has meritorious defenses with regard to the
allegations made in this lawsuit and intends to vigorously defend this action.
Litigation is, however, by its nature uncertain and an unfavorable resolution
of this lawsuit could materially adversely affect our business, results of
operation or financial condition. WE FACE INTENSE COMPETITION IN ALL AREAS OF OUR BUSINESS, AND IF WE DO NOT
COMPETE EFFECTIVELY, OUR BUSINESS WILL BE HARMED. We face intense competition from a number of companies and we expect that
competition will intensify as the movement towards increasing consolidation
within the financial services industry continues. The high levels of
competition we experience have led to pricing pressures in all aspects of our
business. Many of our competitors have significantly greater financial,
technical and marketing resources, greater name recognition and a larger
installed customer base than we do. In the electronic payments market, our principal competitors include:  -
    
    third-party debit network processors, including First Data
Corporation, VISA Debit Processing Services, Midwest Payment Systems
and Fiserv;-
    
    financial institutions that have developed in-house processing
capabilities or services similar to ours, including Wells Fargo, M&I
Bank and Fifth Third National Bank;-
    
    electronic funds transfer software providers, including
Transaction System Architects, S2 and Mosaic; and-
    
    government service providers including J.P. Morgan Chase and ACS. In the risk management market, our principal competitors include:  -
    
    providers of fraud management data and software including Primary
Payment Systems (a subsidiary of First Data Corporation), Equifax,
Experian, TransUnion and RiskWise (a division of Lexis-Nexis of Reed
Elsevier); and-
    
    retail check verification and electronic check processing
providers, including Certegy and Telecheck, a subsidiary of First Data
Corporation. In the ATM management market, our competitors include Cardtronics, First Data
Corporation, Genpass, certain ATM equipment manufacturers and numerous
independent service organizations (ISOs). 27




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In the global outsourcing market, our competitors include:  -
    
    outsourcing solutions companies, including IBM (which has
recently agreed to acquire another of our competitors, Daksh
eServices), Spectramind/Wipro Ltd, Intelenet Global Services Ltd. and
Infosys Technologies. In the market for electronic transaction processing, the principal factors on
which we compete are price and service levels. The future growth of our
revenues in this market is dependent upon securing an increasing volume of
transactions. If we cannot control our transaction processing expenses, we may
not remain price competitive and our revenues will be adversely affected. Our
revenues can also be adversely affected if we are required to make pricing
concessions to retain significant processing customers. In addition, some of
our competitors have indicated that they may be prepared to provide customer
prospects with up-front cash incentives to acquire or retain their processing
business. Given that these competitors have substantially greater financial
resources than we do, it will be difficult for us to obtain significant new
processing customers, or retain the customers we have, if this approach becomes
a significant competitive factor. We have also seen an effort by processors such as First Data Corporation and
VISA that are affiliated with branded networks to seek exclusive processing
relationships with the debit card-issuing financial institutions that subscribe
to their networks. Ownership or control of a branded network may also enable
these competitors to influence the interchange fees financial institutions
receive from retailers who accept transactions from the debit cards issued by
these network participants. We are unable to predict whether this trend towards
an increasing level of vertical integration between transaction processors and
branded debit networks, and the horizontal integration resulting from the
combination of First Data Corporation and Concord EFS, will have a positive or
negative impact upon our processing business over the long-term. Our software business competes primarily upon the basis of the quality and
reliability of our software and its conformance to the current and future
requirements of our customers. If we do not maintain the technological
relevance of our software offerings or fail to anticipate shifts in customer
requirements, our ability to sell our software products will be impaired. Competition for our risk management products is based primarily on the quantity
and quality of the data and data analytic capabilities available to us for this
purpose and, to a somewhat lesser degree, price. Our competitive position in
these markets could be harmed if our competitors were able to compile different
data sources and analytical capabilities that proved to be more effective than
our products. In addition, we continue to experience competitive pressure on
the pricing for our check verification service. In the market for ATM deployment, processing and management services, the
primary basis of competition is industry knowledge and experience, price and
service levels. Our ability to sell additional machines and processing
contracts in this market is dependant on our ability to control our costs while
maintaining effective levels of customer service. If we are not successful in
these efforts we will not achieve the objectives we have for our ATM management
business. Our business process management and information technology services offerings
compete primarily on the basis of the quality of service levels and, to some
degree, price. The future growth of this aspect of our business is dependent on
demonstrating to our current and prospective customers that we are a dependable
and efficient service provider. In addition to our current competitors, it is reasonable to expect that we will
encounter substantial competition from new companies. No assurance can be given
that we will be able to compete effectively against current and future
competitors. Increased competition could result in price reductions, reduced
gross margins or loss of market share. IF WE EXPERIENCE SYSTEM FAILURES, THE PRODUCTS AND SERVICES WE PROVIDE TO OUR
CUSTOMERS COULD BE DELAYED OR INTERRUPTED, WHICH WOULD HARM OUR BUSINESS AND
REPUTATION AND RESULT IN THE LOSS OF CUSTOMERS. Our ability to provide reliable service largely depends on the efficient and
uninterrupted operations of our computer and telecommunications network systems
and our data centers. Any significant interruptions could severely harm our
business and reputation and result in a loss of revenue and customers. We could
also be required to apply substantial amounts of our available cash to fund our
settlement obligations and it is possible that we would not have 28




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sufficient resources in the event of a severe and persistent outage. Our
systems and operations could be exposed to damage or interruption from fire,
natural disaster, unlawful acts, power loss, telecommunications failure,
unauthorized entry and computer viruses. Although we have taken steps to
prevent system failures, we cannot be certain that our measures will be
successful and that we will not experience service interruptions. Further, our
property and business interruption insurance may not be adequate to compensate
us for all losses or failures that may occur. We expect to expend significant
amounts to upgrade the redundancy of our data centers during 2004. OUR SALES OF IT SERVICES HAVE
BEEN DECLINING AND OUR LARGEST IT SERVICES CONTRACT EXPIRES IN
MARCH 2005. The revenues we received
under our largest IT services contract declined approximately 36% during the six
months ended June 30, 2004 as compared to the same period ended 2003. Although
this contract contains minimum spending targets of $43 million per year for the
software development and maintenance services, further
efforts at expense reduction by the customer could cause the revenues
we receive under this contract to continue to decline. We expect that
sales under this contract will
decline in 2004 from the levels seen in 2003. This contract expires
in March 2005. We cannot predict whether this contract will be renewed or
extended after its scheduled expiration, although we would not expect any
extension of this contract to incorporate minimum spending targets
approximating those in the current agreement. LEGISLATION OR REGULATION COULD HARM OUR ABILITY TO COLLECT AND USE DATA,
INCREASE OUR OPERATING COSTS OR OTHERWISE HARM OUR BUSINESS. Existing and new laws and regulations relating to consumer privacy protection
could harm our ability to collect and use consumer data, increase our operating
costs or otherwise harm our business. We collect personal data about consumers
for use in our risk management products. Due to the increasing public concern
over consumer privacy rights, Congress and state legislatures have adopted and
are considering adopting laws and regulations restricting the purchase, sale
and sharing of personal information about consumers. A material increase in the
scope of these types of restrictions could impair the efficacy of our risk
management products. The federal financial modernization law, known as the Gramm-Leach-Bliley Act,
imposes significant consumer information privacy requirements on any entity
engaged in the business of providing financial services, including entities
that provide services to financial institutions. Federal agencies, such as the
Comptroller of the Currency and the Federal Trade Commission, have issued
regulations to implement these requirements. The Act requires covered companies
to develop and implement policies to protect the security and confidentiality
of consumers nonpublic personal information and to disclose those policies to
consumers before a customer relationship is established and annually
thereafter. In addition, the Act requires covered companies to give an opt-out
notice to consumers before sharing consumer information with third parties. The
opt-out notice requirement in the Act is subject to several exceptions for
credit reporting and fraud prevention purposes. Although we believe these
exceptions apply to our business, government agencies could interpret their
regulations in a manner that could expand the scope of the Act in ways that
could adversely affect our business. In addition, even if the regulations do
not affect us directly, uncertainty over the scope of the regulations could
make financial institutions unwilling or reluctant to share consumer-related
information with us. The Gramm-Leach-Bliley Act does not prohibit state legislation or regulations
that are more restrictive on our collection and use of data. More restrictive
legislation or regulations have been introduced in the past and could be
introduced in the future in Congress and the states. For example, in the past
legislation has been proposed which would require consumers to opt in to any
plan, which would allow their nonpublic personal information to be disclosed.
We are unable to predict whether more restrictive legislation or regulations
will be adopted in the future. Any future legislation or regulations could have
a negative impact on our business. Regulations are currently being considered regarding the application of the
Americans with Disabilities Act (ADA) to ATM networks. In addition, the
network rules that govern the transmission of transactions originating at ATMs
will require us and the customers of our ATM management business to upgrade the
encryption capabilities of our collective ATM devices by the end of 2006.
These regulations and requirements could require us to retire or retrofit
portions of the ATM base we own and could motivate some of our customers to
elect to retire their ATMs. It is also possible that existing ATM networks will
be exempted from any future regulations under the ADA. We are unable at this
time to determine whether, and to what extent, any final regulations issued
under the ADA or the network rule revisions will impact our business. 29




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IF THE SECURITY OF OUR DATABASES IS COMPROMISED, OUR REPUTATION COULD SUFFER
AND CUSTOMERS MAY NOT BE WILLING TO USE OUR PRODUCTS AND SERVICES. If the security of our databases is compromised, our business could be
materially adversely affected. In our electronic payments and risk management
businesses, we collect personal consumer data, such as names and addresses,
social security numbers, drivers license numbers, checking and savings account
numbers and payment history records. Unauthorized access to our databases could
result in the theft or publication of personal confidential information and the
deletion or modification of personal records or otherwise cause interruptions
in our operations. These concerns about security are increased when we transmit
information overseas or over the Internet. A security or privacy breach may:  -
    
    deter customers from using our products and services;-
    
    harm our reputation;-
    
    expose us to liability;-
    
    increase our operating expenses to remediate problems caused by the breach; and-
    
    decrease market acceptance of electronic commerce transactions in general. WE MAY EXPERIENCE SOFTWARE DEFECTS, DEVELOPMENT DELAYS AND INSTALLATION
DIFFICULTIES, WHICH COULD HARM OUR BUSINESS AND REPUTATION AND EXPOSE US TO
POTENTIAL LIABILITY. Our services and products are based on sophisticated software and computing
systems and we often encounter delays when developing new products and
services. Further, the software underlying our products and services has
occasionally contained and may in the future contain undetected errors or
defects when first introduced or when new versions are released. In addition,
we may experience difficulties in installing or integrating our products and
technologies on platforms used by our customers or in new environments, such as
the Internet. These types of issues required us to record a $0.5 million
provision for contract loss charge in the second quarter of 2004. Defects in
our software products, errors or delays in the processing of electronic
transactions or other difficulties could result in:  -
    
    delays in market acceptance;-
    
    additional development or installation costs;-
    
    diversion of technical and other resources;-
    
    loss of customers;-
    
    negative publicity; and-
    
    exposure to liability claims. Although we attempt to limit our potential liability for warranty claims
through disclaimers and limitation-of-liability provisions in our license and
client agreements, we cannot be certain that these measures will be successful
in limiting our liability. THERE ARE A NUMBER OF RISKS ASSOCIATED WITH OUR INTERNATIONAL SALES AND
OPERATIONS THAT COULD HARM OUR BUSINESS.
Because we currently sell some of our products and services on a global basis
and provide outsourcing services from India, our business is subject to risks
associated with doing business internationally. During the first six months of
2004, we generated approximately 12% of our net sales outside of the United
States and we presently anticipate that our international efforts will
constitute a higher percentage of our net sales in future periods. Our future
results could be harmed by a variety of factors, including:  -
    
    changes in foreign currency exchange rates;-
    
    changes in a specific countrys or regions political and
economic conditions, particularly in emerging markets;  -
    
    potentially unfavorable tax rules;-
    
    tariffs, duties and other trade barriers;-
    
    reduced protection for intellectual property rights;-
    
    challenges in managing widespread operations;-
    
    changes in foreign laws and regulatory requirements or in foreign policy; and-
    
    varying business practices in foreign countries. 30




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We have prepared sensitivity analyses to assess the impact of hypothetical
changes in foreign currency rates on our income before tax for the three and
six months ended June 30, 2004. Based upon these analyses, we estimate that a
10% adverse change in the exchange rate between the U.S. dollar and the British
pound, Indian rupee and Canadian dollar would have reduced our reported income
before taxes in the three and six month periods ended June 30, 2004 by
approximately $1 million and $3 million, respectively. In addition, the process of selling our outsourcing services typically involves
visits to our sites in India by prospective customers. Increased levels of
international tension can result in prospective clients postponing or canceling
plans to visit our facilities, lengthening the sales cycle and otherwise
inhibiting our ability to grow this business. Political opposition to the use
of offshore resources such as our India-based operations and domestic security
concerns that can make it more difficult for foreign nationals to obtain U.S.
visas can potentially have a similar effect. CHANGES IN INDIAN TAX LAWS
COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our Indian software development and business process management operations
qualify for tax incentives associated with businesses that operate within
designated geographic locations. These incentives generally provide us with
exemptions from Indian tax on certain business income generated from these
operations and phase out through March 2009. We cannot assure you that these
tax benefits will be continued in the future at their current levels or at all.
If our Indian tax benefits are reduced or eliminated, our taxes in future
periods would increase. Such an increase could reduce our profits. WE FACE TERMINATION AND COMPLIANCE RISKS WITH RESPECT TO OUR GOVERNMENT
CONTRACTS AND WE EXPECT OUR REVENUES FROM THIS BUSINESS TO DECLINE IN
UPCOMING PERIODS. All of our government EBT contracts can be terminated at any time, without
cause, by the contracting governmental entity. We realized
approximately 10% of
our net sales in the first six months of 2004 pursuant to contracts of this type. If a government contract is so terminated,
we are generally entitled only to receive compensation for the services
provided or costs incurred at the time of termination and a reasonable profit
on the contract work performed prior to the date of termination. In addition,
all of our government contracts require us to comply with various contract
provisions and procurement regulations, and in some cases, accounting
requirements. Violations of some of these provisions could, if not cured,
result in termination of the contract and fines. Although we continue to
pursue new EBT contracts, we cannot predict whether our bids will be
successful and, in any event, we expect the revenues we receive from
EBT activities to decline during the remainder of 2004 due to
scheduled contract expirations. We expect this trend to continue
during 2005, and if we are not successful in introducing additional
EBT-related services, for the foreseeable future. WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS. Despite our efforts to protect them, third parties may infringe or
misappropriate our intellectual property rights, or otherwise independently
develop substantially equivalent products and services. The loss of
intellectual property protection or the inability to secure or enforce
intellectual property protection could harm our business and ability to
compete. We rely on a combination of trademark and copyright laws, trade secret
protection and confidentiality and license agreements to protect our
trademarks, software and know-how. We have also applied for patent protection
on some of the features of our newer products. We may be required to expend
significant resources to protect our trade secrets and monitor and police our
intellectual property rights. Third parties may assert infringement claims against us in the future. In
particular, there has been a substantial increase in the issuance of business
process patents, which may have broad commercial implications. Claims for
infringement of all types of patents are a common source of litigation. If we
become subject to an infringement claim, we may be required to modify our
products, services and technologies or obtain a license to permit our continued
use of those rights. We may not be able to do either of these things in a
timely manner or upon reasonable terms and conditions. Failure to do so could
seriously harm our business and operating results. In addition, future
litigation relating to infringement claims could result in substantial costs to
us and a diversion of management resources. Adverse determinations in any
litigation or proceeding could also subject us to significant liabilities and
could prevent us from using some of our products, services or technologies. PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT A
CHANGE IN CONTROL. Provisions of our certificate of incorporation and bylaws and Delaware law may
delay or prevent a change in control of our Company that you may consider
favorable. These provisions include the following: 31




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-
    
    no cumulative voting by stockholders for directors;-
    
    a classified board of directors with three-year staggered terms;-
    
    the ability of our board to set the size of the board of
directors, to create new directorships and to fill vacancies;-
    
    the ability of our board to issue preferred stock, without
stockholder approval, with rights and preferences that may be superior
to our common stock;-
    
    the ability of our board to amend our bylaws;-
    
    a prohibition of stockholder action by written consent;-
    
    advance notice requirements for stockholder proposals and for nominating candidates to our board;-
    
    restrictions under Delaware law on mergers and other business
combinations between us and any holder of 15% or more of our
outstanding common stock;-
    
    a requirement that 66-2/3% of our stockholders and 66-2/3% of our
directors approve certain corporate transactions, including mergers
and consolidations, sales of assets or amendments to our certificate
of incorporation; and-
    
    we have adopted a stockholder rights plan, which discourages the
unauthorized acquisition of 15% or more of our common stock or an
unauthorized exchange or tender offer. 32




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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are filed as part of this report: ExhibitNo.
    
    Description
    
    Method of filing2.1
    
    Purchase and Sale Agreement, dated April 13, 2004, by and between the
Company, Penley Inc. and certain individual parties thereto
    
    Filed herewith3.1
    
    Amended and Restated Certificate of Incorporation (incorporated by
reference to Exhibit 3.1 to the Registration Statement on Form S-1
(the S-1) filed by the Company with the Securities and Exchange
Commission (the Commission) on April 4, 2000, Registration No.
333-33992)
    
    *3.2
    
    Bylaws (incorporated by reference to Exhibit 3.2 to the S-1)
    
    *4.1
    
    Form of common stock certificate (incorporated by reference to Exhibit
4.1 to Amendment No. 1 to the S-1 filed by the Company with the
Commission on May 15, 2000 (Amendment No. 1), Registration No.
333-33992)
    
    *4.2
    
    Form of Rights Agreement by and between the Company and Rights Agent,
(incorporated by reference to Exhibit 4.2 to Amendment No. 1)
    
    *4.3
    
    Certificate of Designation of Series A Participating Preferred Stock
(incorporated by reference to Exhibit 4.3 to the Companys Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000)
    
    *31.1
    
    Section 302 Certification by Mr. Paul F. Walsh
    
    Filed herewith31.2
    
    Section 302 Certification by Mr. Thomas S. Liston
    
    Filed herewith32.1
    
    Section 906 Certification by Mr. Paul F. Walsh and Mr. Thomas S. Liston
    
    Filed herewith
 *Incorporated by reference (b) Reports on Form 8-K On May 5, 2004, the Company furnished a report on Form 8-K which included,
pursuant to Items 7 and 9 of that form, a press release announcing the
Companys first quarter 2004 financial results. This press release included
the Companys condensed consolidated balance sheets at March 31, 2004 and
December 31, 2003, and its condensed consolidated statements of operations and
cash flows for the three month periods ended March 31, 2004 and March 31, 2003. 33




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. eFunds Corporation
(Registrant)Date: August 5, 2004
    /s/ Paul F. WalshPaul F. WalshChief Executive Officer and Chairman Date: August 5, 2004
    /s/ Thomas S. ListonThomas S. ListonChief Financial Officer 34




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Index to Exhibits ExhibitNo.
    
    Description
    
    Page Number2.1
    
    Purchase and Sale Agreement, dated April 13, 2004, by and between the
Company, Penley Inc. and certain individual parties thereto31.1
    
    Section 302 Certification by Mr. Paul F. Walsh31.2
    
    Section 302 Certification by Mr. Thomas S. Liston32.1
    
    Section 906 Certification by Mr. Paul F. Walsh and Mr. Thomas S. Liston
 35